Field of Study: Accounting Employee stock purchase plans, often known as ESPPs, are programs that enable employees to purchase company stock via elective payroll deductions. Typically, those deductions will accrue over a set period of time, often six months. At the end of that period, the accumulated money is then used to buy stock and a new six-month period starts. ESPPs are a great incentive for employees, but how are they different from any other kind of equity compensation like options or restricted stock? David Outlaw, director of Valuation and HR Advisory Services at Equity Methods, provides us with details on the different types of ESPPs, reasons companies offer them, common structures and tax qualifications.

Field of Study: Accounting Special purpose acquisition companies, SPACs, also known as “blank check companies” raise money but are listed on an exchange before they even own any assets. Their goal is to acquire a privately held company within two years. These are both good enough reasons to be on the SEC’s radar. The SEC not only looks closely at filings and disclosures by SPACs in an effort to protect the public interest, but also, in April 2021, issued new guidance on the treatment of SPAC warrants with neither previously issued proposals nor a comment period. This was an uncharacteristic move that caught financial professionals by surprise. Zac McGinnis, managing director at Riveron Consulting and Josh Schaeffer, director at Equity Methods, provide a more in-depth discussion on SPACs and their execution.

Field of Study: Accounting Related party transactions seem to be a recurring issue, and the reason is primarily two-fold. One, there's been a significant amount of related party frauds that were discovered only after the fact. And two, there's been criticism of related party disclosures in that they don't provide an accurate view of the related party activity that took place within the reporting entity. Identifying related party relationships and related transactions is not as straightforward as one might think. John Fleming, CPA, discussion leader at Kaplan Financial Education, focuses on the importance of such transactions and their impact on the fair representation of financial statements.

Field of Study: Taxes Subsequent to the March 2020 emergency declaration issued by President Trump in response to the coronavirus pandemic, there have been several major disaster relief declarations. As the pandemic seems like it’s never ending, the IRS has to plan accordingly and extend most of its tax treatments with respect to COVID-19 and/or provide additional guidance where necessary. Barbara Weltman, president of Big Ideas for Small Business, gives us COVID-19 related IRS updates, discusses the tax treatment of recent tax cases, and explores ways tax professionals can boost their data security and better protect client information.

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1. Employee Stock Purchase Plans – Why Offer One?

2. Accounting & Valuation of SPACs

3. Related Party Transactions – A Recurring Issue

4. IRS Updates

CPA REPORT SUBSCRIBER GUIDE

SEPTEMBER 2021 Summary Page i [p. 1]

CPE Requirements iii [pp. 3–5]

Segment One 1–1 [pp. 7–39]

Segment Two 2–1 [pp. 41–70]

Segment Three 3–1 [pp. 71–101]

Segment Four 4–1 [pp. 103–133]

Sememt Five 5–1 [pp. 135–158]

Evaluation Form A–1 [pp. 159–160]

Index B–1 [pp. 161–164]

Group Live Attendance Form C–1 [p.165]

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: Accounting (NFP) The regulators have been busy providing guidance and not-for-profit accountants have been even busier preparing for the slew of new standards coming out. Kaplan Financial Education discussion leader Allen Fetterman provides an update on where things stand with revenue recognition, leases, CECL, goodwill and intangible assets, gifts in kind, accounting for pandemic-related issues, and other topics impacting not-for-profit organizations.

5. Revenue Recognition, Leases and Other Accounting Updates for NFPs

Summary Page (continued)

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e CPE Requirements and Group Live

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 September 24, 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. Employee Stock Purchase Plans – Why Offer One?Learning Objectives:

Segment Overview:

Recommended Accreditation:Reading (Optional for Group Study):

Running Time:

Video Transcript:

Course Level:

Course Prerequisites:

Advance Preparation:

Expiration Date: November 6, 2022

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

None

1 hour group live 2 hours self-study online

Update

“ESPPs that Work for You: Top Five Lessons Learned.“ “Case Study: ESPP Performance Across Economic Cycles” “The Key to Engagement: Designing an ESPP to Drive Your People Strategy” “ESPPs: Financial Reporting Complexity”

See page 1–12.

See page 1–22.

34 minutes

Employee stock purchase plans, often known as ESPPs, are programs that enable employees to purchase company stock via elective payroll deductions. Typically, those deductions will accrue over a set period of time, often six months. At the end of that period, the accumulated money is then used to buy stock and a new six-month period starts. ESPPs are a great incentive for employees, but how are they different from any other kind of equity compensation like options or restricted stock? David Outlaw, director of Valuation and HR Advisory Services at Equity Methods, provides us with details on the different types of ESPPs, reasons companies offer them, common structures and tax qualifications.

Upon successful completion of this segment, you should be able to: l Understand the distinct differences of ESPPs vs.other stock

compensation plans and restricted stock, l Identify the different design levers of ESPPs and the ways

they differ, l Recognize the accounting treatment of ESPPs based on their

features, and l Understand the remeasurement triggers and common

modification drivers.

Field of Study: Accounting

A. Employee Stock Purchase Plans

i. Employees purchase stock l Elective payroll deductions

ii. Stock is discounted

iii. Other features l Resets

b Buy at a low point

B. Distinct Differences of ESPPs

i. Legally distinct

ii. Separate shareholder approval

iii. Voluntary

iv. Improved economics l Better stability than RSU l Upside of an option

v. Broad-based program l Lower cost

C. Why Consider ESPPs

i. Drives ownership culture

ii. Shorter hold to get benefit

iii. Attracts talent

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I. ESPPs: Overview

A. ESPP Design Levers

i. Tax qualification – IRC section 423 l Capital gain tax treatment

ii. Percentage of discount offered

iii. Lookback l Buy at a discount from

b Lower of the beginning

or b Ending stock price

iv. Length of offering & purchase periods

v. Reset or rollover mechanisms

B. Exceptions

i. Companies may offer very basic plans l 20% discount l No lookbacks l No tax qualification under IRC

section 423

ii. Companies offer up to 5% discount l Not expensed on the P&L

C. Why Do ESPPs Add Value to Participants?

i. Contributing a fixed amount

ii. Locked in percentage of gain

iii. Lookback feature l Discount percentage floor of gain

D. Lookback Dichotomy

i. No lookback l Simple discount or matching

program l Quarterly purchase and offering

periods

ii. Lookback l Six months offering with a single

purchase l Richer benefit

b Two-year plan b Four six-month purchases

II. ESPP Design Levers

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A. Switching ESPPs

i. Shareholder approval

ii. Latitude with new plan

iii. Understand costs involved

iv. Roll out new plan at the end of an offering period

B. ESPPs Differences

i. Participation rules

ii. Define what falls under compensation

iii. Ability to change participation

iv. Beware of accounting ramifications

v. Cash infusions

vi. Auto enrollment

vii. International differences

C. Qualifications for Favorable Tax Treatment

i. Open to employees only

ii. Not transferable

iii. Approved by shareholders

iv. Eligibility l Broad based and non-

discriminatory

v. Discount can't be higher than 15%

vi. Term can't be more than l 27 months – lookback l 5 years – no lookback

vii. $25,000 cap

D. If Tax Qualified

i. Hold stock without selling for at least l 2 years from offering date l 1 year from purchase date l Tax on sale is capital gains

ii. Selling before that point l Disqualified disposition l Tax on sale is ordinary income l Capital gains for any subsequent

movement

III. ESPP Options and Tax Treatment

A. Estimating Fair Value

i. Simple discount plan l Discount Percentage x Stock

Price

ii. Lookback feature l Akin to an option

B. Put Option

i. Price goes down

ii. Payout remains flat

“The question we often get is what actually drives the resulting value then. And the main thing honestly is the terms of the plan.”

— David Outlaw

IV. Valuing ESPP Components

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Outline (continued)

V. Accounting Models and RemeasurementA. Expense Model

i. Estimate the number of shares at the time of the offering

Estimated contributions

Purchase Price

B. Classification – Equity vs. Liability

i. Lookback feature l Equity classified

ii. Discount plan – no lookback l Classic liability

C. Remeasurement Triggers

i. Mark to market l Revalue plan l No accounting grant date l Cash infusion at a very low level

D. Common Drivers of Modifications

i. Resets or Rollovers

ii. Changes l Increases to the withholding rate

VI. ESPPs – Looking ForwardA. Why Are ESPPs Shareholder Friendly?

i. Drive ownership culture

ii. P&L and cashflow friendly

B. David Outlaw’s Final Thoughts

i. Educate yourself on ESPPs

ii. Have a seat at the cross-functional table l Knowledge & analytical skills l Avoid surprises

iii. Model out different scenarios l Cost vs. benefit

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Discussion Questions

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1. Employee Stock Purchase Plans – Why Offer One?

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

“In this segment, David Outlaw provides us with details on the different types of ESPPs, reasons companies offer them, common structures and tax qualifications.”

l Show Segment 1. The transcript of this video starts on page 1–22 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 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. Employee stock purchase plans (ESPPs) allow employees to purchase stock in the companies they work for. What are the main features of such plans? Does your organization offer an ESPP to employees?

2. ESPPs can come in many different forms. What are the different types of ESPPs and how do they differ? Which form of ESPP does your organization prefer?

3. Even outside the design, ESPPs may be different. What are some of the ways ESPPs are different in terms? How does your organization treat such differences?

4. As long as they meet certain qualifications, ESPPs can get preferential tax treatment. What are the requirements for ESPPs to get favorable tax treatment? How does your organization seek to maintain compliance to achieve favorable tax treatment?

5. A key issue related to ESPPs is their valuation. How can the fair value of an ESPP be estimated? How do you or your organization measure fair value of your ESPPs?

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

Instructions for Segment

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6. Accounting guidance for ESPPs is provided by ASC-718 Compensation—Stock Compensation. What are the main provisions of ASC-718? How does your company maintain compliance with ASC-718’s requirements?

7. Certain events may trigger remeasurements of ESPPs. What are some of the events that may cause ESPPs to be remeasured or revalued? How does your organization handle such events?

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s1. Employee stock purchase plans (ESPPs)

allow employees to purchase stock in the companies they work for. What are the main features of such plans? Does your organization offer an ESPP to employees? l Employees purchase stock at

discounted prices through elective payroll deductions.

l Other features b Resets allow employees to buy at

a low point l Purchase price is based on any

price declines that happen over the offering period

b Employees get to buy stock with different types of discounts, which makes it a great intersection of compensation and benefit.

l Distinct Differences of ESPPs b Legally distinct b Separate shareholder approval b Voluntary b Improved economics over

traditional equity compensation plans l Better stability than RSU l Upside of an option

b Broad-based program l Participant response based on

personal/organizational experience

2. ESPPs can come in many different forms. What are the different types of ESPPs and how do they differ? Which form of ESPP does your organization prefer? l Different in ways that are unique to

ESPPs l Differences in design

b Tax qualification – IRC section 423 l Capital gain tax treatment

b Percentage of discount offered

b Companies offer up to 5% discount l Exceptions

v Companies may offer very basic plans k 20% discount k No lookbacks k No tax qualification

under IRC section 423 b Lookback

l Buy at a discount from v Lower of beginning or v Ending stock price

l Lookback dichotomy v No lookback

k Simple discount or matching program

k Quarterly purchase and offering periods

v Lookback k Six months offering

with a single purchase k Richer benefit

j Two-year plan j Four six-month

purchases b Length of offering & purchase

periods b Reset or rollover mechanisms

l Participant response based on personal/organizational experience

3. Even outside the design, ESPPs may be different. What are some of the ways ESPPs are different in terms? How does your organization treat such differences? l ESPPs Differences

b Participation rules b Define what falls under

compensation b Ability to change participation b Beware of accounting

ramifications

Suggested Answers to Discussion Questions

1. Employee Stock Purchase Plans – Why Offer One?

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sb Cash infusions b Auto enrollment b International differences

l Participant response based on personal/organizational experience

4. As long as they meet certain qualifications, ESPPs can get preferential tax treatment. What are the requirements for ESPPs to get favorable tax treatment? How does your organization seek to maintain compliance to achieve favorable tax treatment? l Qualifications for Favorable Tax

Treatment b Open to employees only and not

transferable b Approved by shareholders b Eligibility must be broad based

and non-discriminatory b Discount can't be higher than 15% b Term can't be more than

l 27 months – lookback l 5 years – no lookback

b $25,000 cap on stock purchases l If ESPP is Tax Qualified:

b Employees receive tax treatment similar to IPOs

b Hold stock without selling for at least l 2 years from offering date, and l 1 year from purchase date l Tax on sale is capital gains

b Selling before that point l Disqualified disposition l Tax on sale is ordinary income

l Participant response based on personal/organizational experience

5. A key issue related to ESPPs is their valuation. How can the fair value of an ESPP be estimated? How do you or your organization measure fair value of your ESPPs? l Estimating Fair Value

b Simple discount plan – (Discount Percentage x Stock Price)

b Lookback feature allowing employees to buy at the lower of the beginning or ending price l Akin to an option

v If the price goes up, employees can still buy it at today's price

l Put option v Price goes down v Payout remains flat

l Participant response based on personal/organizational experience

6. Accounting guidance for ESPPs is provided by ASC-718 Compensation—Stock Compensation. What are the main provisions of ASC-718? How does your company maintain compliance with ASC-718’s requirements? l Per ASC-718, entity must have a fair

value at the offering date. b Fair value amount is expensed

over the purchase period. l Expense Model

b Determine total estimated number of shares at time of offering:

b Estimated contributions divided by Purchase price if purchased today

b Apply computed fair value to estimated total number of shares and make necessary adjustments.

l Classification of ESPP b Equity or liability?

l Lookback feature v Equity classified

l Discount plan – no lookback v Classic liability

l Participant response based on personal/organizational experience

Suggested Answers to Discussion Questions (continued)

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remeasurements of ESPPs. What are some of the events that may cause ESPPs to be remeasured or revalued? How does your organization handle such events? l Remeasurement Triggers

b Mark to market accounting – requires revaluation of ESPP each reporting period

b Revaluation occurs if there is no accounting grant date

b Cash infusion at a very low level l Common Drivers of Modifications

b Resets or Rollovers b Changes

l Increases to employee withholding rates

l Participant response based on personal/organizational experience

Suggested Answers to Discussion Questions (continued)

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1. One of the features of an employee stock purchase plan (ESPP) is:

a) employees purchase stock via payroll deductions

b) employees purchase stock at a small premium but pay no tax on any gains from the sale of the stock

c) a lookback feature which allows employees to buy stock at the lowest possible historical price

d) all of the above

2. When compared to other forms of compensation, an ESPP is:

a) not legally distinct but voluntary

b) legally distinct but involuntary

c) legally distinct and voluntary

d) not legally distinct and involuntary

3. If an ESPP is considered ______ under the IRC, then employees ______.

a) qualified, receive ordinary income tax treatment

b) not qualified, get capital gains tax treatment

c) qualified, get capital gains tax treatment

d) not qualified, are not taxed on their ESPP transactions

4. A lookback period in an ESPP allows an employee to purchase a stock at a discount from the ______ of the purchase period.

a) beginning stock price at the beginning

b) lower of the beginning or ending stock price at the end

c) higher of the beginning or ending stock price at the end

d) ending stock price at the end

5. The most common lookback is a:

a) 6 month offering with a single purchase

b) 12 month offering with a single purchase

c) 24 month offering with two 12 month purchases

d) 12 month offering with two 6 month purchases

6. In order to get favorable tax treatment under the IRC an ESPP:

a) may not contain any caps

b) must have a discount of at least 15%

c) must be approved by the Board of Directors only

d) must not be transferable by employees

7. In order to get capital gains treatment, an employee of a tax qualified ESPP must hold the stock for at least ______ from the offering date and ______ from the purchase date.

a) 2 years; 2 years

b) 2 years; 1 year

c) 1 year; 1 year

d) 1 year; 1 year

8. According to ASC-718, an ESPP should be recorded as:

a) equity in all cases

b) a liability if there is a pure discount with a lookback

c) equity if there are look back features

d) a liability in all cases

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. Employee Stock Purchase Plans – Why Offer One?

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9. Recent statistics show ______ in the number of 15% discount plans and ______ in the number of 5% discount ESPPs.

a) an increase; a decrease

b) an increase; an increase

c) a decrease; a decrease

d) a decrease; an increase

10. A non-qualified tax ESPP can give discounts:

a) only less than 15%

b) greater than 5%

c) between 5% and 10%

d) greater than 15%

Objective Questions (continued)

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By David Outlaw Source: https://www.equitymethods.com/articles/espp-plans-work-top-five-lessons-learned/

We’ve spent a lot of time over the last year or two talking to companies and industry friends about employee stock purchase plans (ESPPs). It’s hard to shake the feeling that the pendulum is swinging back toward ESPPs in a big way. With traditional equity programs focusing more on the executive suite, it’s harder for many companies to make broad-based equity grants meaningful to employees. ESPPs are a great way to fill that void, especially since they can scale to employees’ preferred participation levels and come with a built-in profit for participants.

These conversations culminated this month at the WorldatWork Total Rewards

conference, where I presented on the topic with Brit Wittman of Intel, Julie Mrozek of Leidos, and Cherie Curry of Hilton. Between the insights from that panel and the conversations in the hallways of the conference, there were some recurring points about how to make an ESPP suit your specific needs. Here are five key takeaways:

1. ESPPs are becoming more generous (again).

We all know the basic story: Everyone had great ESPPs in place 10-15 years ago before the accounting rules changed. But when FAS 123R went live in 2006, a lot of companies dialed back to “noncompensatory” plans with a 5% discount and no lookback in order to avoid any expense hit.

1–12

Self-Study Option

Reading (Optional for Group Study)

ESPPS THAT WORK FOR YOU: TOP FIVE LESSONS LEARNED

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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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But the pendulum is swinging back the other way, toward more employee-friendly plans. For example, we can look at the reversal of the trend in the size of the purchase discount (Figure 1):

In 2007, there was a drop in the number of 15% discount plans and a spike in the number of plans with a 5% discount or less. But in recent years, the trend has reversed. Plans with a 15% discount are at their highest prevalence since pre-FAS 123R, and 5% discount plans are at their lowest.

In any case, we’re very much looking forward to seeing next year’s data. Based on the conversations we’ve had, we expect to see a continuing trend of ESPPs becoming more generous and more prevalent.

2. ESPPs have more variety than plain vanilla options or RSUs. Use that to your advantage. The accounting guidance in ASC 718 specifically lists out nine types of ESPP, but in reality, the subtle variations create an even wider range of plan types. Some are objectively more employee-friendly, but there is no single right answer for everyone. The key lies in perceived value by employees, or how much value they subjectively place on the plan.

This isn’t the venue to walk through every single possibility, but here are some of the main plan features to consider.

First is the discount, which is straightforward enough. Employees will typically perceive the value fairly close to its objective value.

Second is a lookback feature, where the purchase price is a discount from the lower of the beginning or ending stock price in the period. Objectively, this is extremely valuable, because it opens up a huge range of possible upside while maintaining downside protection. But it can be easy to understand just how much value it can add without the right communication. (Though of course, it’s easy for employees to understand once that first big windfall check hits their wallet!)

Third is the offering length. Again here, the longer runway objectively unlocks a wide range of possible upside, but communication and examples are key to employee understanding.

Finally, there are resets or rollovers, where the lookback price in a multi-period offering ratchets downward when the stock price decreases. For anyone looking to maximize employee upside while remaining in the realm of “standard” ESPPs, this is a great plan type to consider.

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3. “Non-standard” plans may not be for everyone, but they’re the right answer for some.

There’s more reason than ever today to explore beyond the standard plans. If your employee base is unlikely to hold shares long enough to qualify for IRC §423 tax treatment—which is true for many companies—then the value in offering a qualified plan is limited. And if you don’t need your plan to qualify under IRC §423, then the design handcuffs are gone.

Without binding qualification criteria, a plan can give discounts greater than 15%, provide offerings longer than 27 months, or limit eligibility to a smaller employee population. Plus, a non-qualified plan always gives the company a tax deduction at settlement.

One of the more interesting features that’s come up lately is an auto-enrollment feature along the lines of what many companies do with 401(k) plans. Most often, we see these in companies that expect minimal withdrawals and who are undergoing a transition like an IPO. An auto-enrolling ESPP lets employees get in on the ground floor and helps kick-start an ownership culture.

4. Communication and education drive engagement and employee value. Perhaps the biggest takeaway from the experience of my co-panelists at WorldatWork was the importance of communication. Regardless of the plan terms, they all reiterated the importance of being proactive in driving employee engagement.

We all know that just handing a prospectus to an employee isn’t sufficient, but what are some other avenues? Plain-English FAQs or reference slides are one, as is including ESPP information in annual total rewards statements. Town hall meetings or webinars are another, especially if they coincide with enrollment periods. And

sometimes, going even bigger is necessary, such as a roadshow to support the launch of a new plan or the onboarding of new employees through a merger.

Intrigued by Intel’s astronomical participation rates (over 70% worldwide, and nearly 80% in the US), one audience member asked Brit how they managed to have such wide involvement. His answer was to embed the plan in the culture as much as possible. For example, splash purchase information onto the Intranet site and common area screens to reach as many people as possible. And once the plan really is part of the culture, fellow employees become the best salespeople for getting new folks to participate.

5. Use data and scenario modeling to inform your decisions.

It’s almost a cliché at this point, but data-driven decision-making is really important in this day and age.

Fortunately, ESPPs lend themselves very well to modeling. Sometimes, this is simple: What would our expense be if the stock price were $X, $Y, or $Z? And the participation rate were A, B, or C? And how would employee payouts compare to that expense?

Some of our clients even go as far as to simulate the whole range of potential payoffs to get a clearer idea of costs and benefits (Figure 2):

This level of detail can give you solid estimates on questions like “what’s my average expected employee gain?” and “how likely is an employee to have a gain higher than our accounting cost?” (For our curious readers, the answers in the case shown here are $1,354 and 60%, respectively.)

While this level of sophistication isn’t needed in every case, some amount of quantitative modeling is table stakes in the world today. We recommend at least starting with A) scenario modeling high/medium/low stock price cases and B) backtesting the numbers over the last few

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years of actuals as a baseline for real-world outcomes.

A major side benefit of modeling and visualization is building the case for senior management that your ESPP recommendation is well-grounded. There are a lot of opinions about ESPP designs, some more insightful than others, and our encouragement is to analyze the data before you make your decisions.

Parting thoughts All in all, this underscores the importance of being thoughtful. ESPPs are not one-size-fits-all, and there’s not a single answer that works best for every company and every culture. But by weighing a few alternatives, modeling out the possibilities, and communicating clearly to your employees, you can have a plan that works best for you.

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By David Outlaw and Nick Faris Source: https://www.equitymethods.com/articles/case-study-espp-performance-across-economic-cycles/

The recent market volatility has put employee stock purchase plans (ESPPs) at the front of our mind a lot this year. While much of the compensation focus has been on restoring incentives for performance awards, we see ESPPs as a sort of bellwether for a company’s employee sentiment.

For most companies, ESPP participation has remained steady or even ticked up. After all, ESPPs are a powerful engagement tool that delivers excellent value across business cycles (as we’ll illustrate in our case below). The data supports this view, too: In recent polling of webcast participants, about 64% of respondents with ESPPs observed behavior roughly similar to the past, and a further 22% observed more interest or participation than normal.

At other firms, employee participation has declined, perhaps due to pay cut or furlough concerns. Among our client base (where we have detailed participation data), a substantial number of firms saw withdrawals increase by 40% or more. At

some companies in hard-hit industries, withdrawals rose more than tenfold.

There’s no compensation plan that can avoid the painful realities of economic distress. But as some companies look forward to building a future amidst volatility and uncertainty, we’re reminded that ESPPs are an excellent equity vehicle to help employees ride out this volatility. In this blog post, we’ll explore some of the costs and benefits that different ESPP types can deliver.

Note that we assume for the case study below that readers have a basic understanding of ESPP mechanics and features. If you’d like to brush up, we recommend the following articles:

The Key to Engagement: Designing an ESPP to Drive Your People Strategy (Workspan article)

ESPPs that Work for You: Top Five Lessons Learned (blog)

Five Ways that West Coast Companies Design ESPPs (blog)

ESPPs: Financial Reporting Complexity (issue brief)

CASE STUDY: ESPP PERFORMANCE ACROSS ECONOMIC CYCLES

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The Case

We selected a firm to study that we felt was fairly representative of a middle-of-the-road case over the last decade, with performance that roughly tracked the broader economy without unusual spikes or crashes in stock price. We’ll refer to them as Company XYZ (names have been changed to protect the innocent). The company is a Fortune 500 consumer staples firm, and our analysis is entirely at arm’s length—they’re not a client and we have no insight into any ESPP plan they may have.

For this case study, we did what we often do for our clients who are considering an ESPP: We ask, “What if this company had issued this plan over the past several years? What would have been the company costs and employee benefits?” So, in our never-ending quest to analyze as much data as possible, we simulated an employee contributing $5,000 during each purchase period in three enrollment designs, starting in May 2012 and running through April 2020. Here are the relevant plan attributes:

l Discount only. This is the most basic design we’ll cover. It assumes a six-month contribution period, at the end of which the total contributions are used to purchase shares at a 15% discount from the purchase date price.

l Lookback. This design also assumes a six-month contribution period, at the end of which the total contributions are used to purchase shares. However, with the lookback, the purchase price is a 15% discount from the lower of the enrollment date price and the purchase date price.

l Rollover. This plan design is the most generous we analyze here. It consists of a 24-month offering with four separate six-month contribution periods. Each period culminates with the contributions being used to purchase shares at a 15% discount from the lower of the enrollment date price and the purchase date price. However, if a new offering begins at a lower price while the current offering is outstanding, then the employee is rolled over into that new offering and locking in that lower price.

For each of these designs, we analyze the quantifiable costs and benefits for our simulated employee. Costs are measured as the compensation expense recognized by the company, and benefits are measured as the net gain to the employee at purchase, above and beyond their $5,000 contribution for that period.

Analysis: Discount Only

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First, let’s analyze a plan with only a 15% discount. The way these plans work, the cost and benefit will necessarily track almost identically to one another—the only small differences you might see are due to things like share rounding and particular systems conventions.

This makes discount-only plans relatively unexciting as a benefit offering. It’s certainly nice for the employee to gain access to that 15% discount, but it comes as cost straight out of the company’s pocket. It’s effectively a straightforward compensation arrangement with no further upside or downside.

Analysis: Lookback

Next, we analyze the lookback design. Due to the way the lookback works, the employee is guaranteed a minimum gain equal to the discount-only design, but also

has unlimited upside potential when the market value appreciates. In the example above, you can see the elevated gain in blue, which reflects the additional gains in a rising market. In some particularly bullish periods, the employee gain was as much as 50%!

The cost of a lookback design is also higher than discount-only, as it must capture the option-like value of the upside potential. The amount of this extra cost will vary from company to company (just like any award valuation), but will generally be steady and predictable, as shown by the straight orange line above.

The net effect in this case is an employee benefit that’s 53% higher than the baseline discount-only design, for a cost that’s only

29% higher—definitely a good bang for this company’s buck.

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Analysis: Rollover

Next up is the rollover design. This design incorporates both the lookback and discount features, as well as having four purchases in one offering. The longer runway afforded by multiple purchases per offering adds a lot of value on its own: Since the lookback feature allows the participant to purchase at the lower of the purchase or enrollment date price, it gives the market price more time to climb without the lookback price ratcheting upward.

The other feature that adds a lot of value is the rollover itself, which helps further protect participants from decreases in the market price. If the price declines, which in this case occurs for the April 2015 purchase, the employee rolls over into the new offering at the lower price. This ensures that every employee can always buy at the most favorable price available, and leads to the steep gains seen above in 2016.

On the cost side of the ledger, two features of this design lead to higher expense for the company. One is the longer offering period to accommodate the four purchases. Because of the longer option term embedded in these purchases, the value is higher—just like Black-Scholes with a longer expected term. The other is that any time a rollover is triggered, it triggers an accounting modification and associated incremental expense.

On the whole, this is again a substantial value for the employee at a favorable cost. The employee sees a 136% gain over a discount-only plan—that’s more than twice the value—at only a 43% cost increase to the company. We caution that these results won’t be of the same magnitude for every company. This company had a lower volatility than others might, which leads to lower costs, and of course the last eight years have been a very positive period for stock performance. That said, we do consistently see good ROI for our clients’ money in implementing generous ESPPs like these.

Reviewing the Last Recession

Another angle we want to explore given the current economic uncertainty is what happened in the last recession, and what that can tell us about how ESPPs might behave in a future recession. With the above examples only running from 2012 to 2020, we also tested the period 2007 to 2011 on these same plan designs.

For a discount-only plan, we found again that the costs and benefits (by definition) are approximately equal, albeit with less value delivered in a down market. Keep in mind that this is already more favorable than a traditional equity plan—if you issue an RSU before a market decline, you’re stuck with the higher expense even when low value is actually delivered.

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For a lookback plan, the lookback optionality provides less value to the employee when the price is declining. Employees will still be at least as well off as a discount-only plan, but can start benefiting from the recovery (and potentially from any volatility during the down period) immediately. For this company, we see that costs and benefits roughly align for this plan type.

Finally, we see that rollover plans significantly outperform in periods of recession and volatility. The longer lookback gives employees more time to ride out the down period and benefit from the recovery, while the rollover keeps their purchase price as low as possible if that recovery doesn’t happen smoothly.

Conclusion We’ve always seen ESPPs as a cost-effective way to drive a lot of value to employees, both monetarily and in softer ways like

creating engagement and encouraging an ownership culture. We see these advantages as especially true in uncertain times, where the unique combination of guaranteed gain and windfall upside opportunity can produce a truly differentiated employee benefit without breaking the bank.

Every company is unique, and the fact pattern shown in this case study is just one example that wouldn’t look the same for

everyone. But the cost effectiveness of generous ESPPs, either as a supplement or a replacement for traditional equity plans, has driven a resurgence in their use that we expect to continue in the coming months and years.

If you have any questions about ESPPs, whether you currently have one or are just considering it, please reach out to us or your Equity Methods consultant.

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THE KEY TO ENGAGEMENT: DESIGNING AN ESPP TO DRIVE YOUR PEOPLE STRATEGY

By Takis Makridis and Therese Sebastian Source: https://www.equitymethods.com/articles/the-key-to-engagement-designing-an-espp-to-drive-your-people-strategy/

Employee stock purchase plans (ESPPs) are more than just compensation. They’re an important tool for creating an ownership culture while potentially delivering outsized financial gains at a (usually) modest cost. In some industries, an ESPP is table stakes for competing in a tight labor market. In others, it can be a genuine strategic differentiator.

But ESPPs are not created equal. Even in industries where they’re common, it’s possible to design a program that stands out and delivers greater impact. In this article from the February 2019 issue of Workspan, we discuss the different flavors of ESPPs and ways to help you determine which type is right for your organization. Along the way, we’ll show why ESPPs just might be the most versatile—and underutilized—compensation and employee engagement instrument.

See the story online or get a PDF via the “download” button on this page.

by David Outlaw and Nick Faris Source: https://www.equitymethods.com/articles/espp-financial-reporting-complexity/

Across the country, employee stock purchase plans (ESPPs) are on the rise. In addition, more ESPPs have exotic provisions, such as features allowing for contribution rate changes and reset or rollover provisions.

With this growth in ESPP popularity, there is increasing scrutiny surrounding the financial reporting for these programs. Traditional “pool-based” approaches are running into trouble with external auditors, who are concerned that the imprecision may have material consequences on the final results.

This issue brief, originally published in 2016 and newly updated for 2018, details the rise in popularity of ESPPs. It also looks at exotic design features that are intended to deliver more value, as well as financial reporting best practices.

THE KEY TO ENGAGEMENT: DESIGNING AN ESPP TO DRIVE YOUR PEOPLE STRATEGY

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SURRAN: Employee stock purchase plans, often known as ESPPs are programs available to employees that enable them to purchase company stock via elective payroll deductions. Typically, those deductions will accrue over a set period of time, often six months. At the end of that period, the accumulated money is then used to buy stock and a new six month period starts. It is a continuous process of deducting from payroll and buying stock.

Where it gets really interesting is in the economics of exactly how that happens for employees. It is almost always happening at a discount, which is beneficial for employees and it is also possible to have features like lookbacks, which are the ability to buy the stock at the lower of the price at the beginning or end of that six-month purchase period. So there are some options and upside potential.

There are some other exotic features, such as resets, that allow employees to buy at the low point, which means that the purchase price is based on any price declines that happen over the offering period. Employees get to buy stock with different types of discounts which makes it a great intersection of compensation and benefit.

MORIARTY: Employee stock purchase plans sound like a great incentive for employees, but how are they different from any other kind of equity compensation like options or restricted stock? David Outlaw, director of Valuation and HR Advisory Services at Equity Methods, provides us with the distinct differences.

OUTLAW: We tend to think of it as its own category of benefit. It's not quite stock compensation, it's certainly not based on a bonus, and it's really not a health plan or tuition reimbursement or anything. But it is its own important part of the overall portfolio. And in fact, it is legally distinct as well. It's an entirely separate shareholder approval and legal plan than the rest of the equity comp. So it is actually important to think about it distinctly. As far as some of the key really true differences.

First and foremost, it's voluntary. And so employees can choose to participate if they want to participate. They can participate a little bit, they can participate a lot. And so that gets around some of the concerns that companies might have with, for example, issuing equity lower in the organization where those people might prefer to have more cash, more liquidity in the paycheck in terms of paying their bills month to month.

It also has improved economics in many ways over a traditional equity compensation plan. So, you have essentially better downside stability than even a Restricted Stock Unit or RSU would have. But then you have the upside of an option, and so it's the best of both worlds there.

On the flip side, some things that make it a little bit less advantageous is it really is a best fit as a broad-based program. If it's tax qualified, which we'll talk about later, that does mean it has to be non-discriminatory and available to everyone. And it would have a $25,000 purchase cap, which means that it doesn't necessarily scale to executive compensation levels in the way that a traditional equity program would do fairly well.

Video Transcript

1. Employee Stock Purchase Plans – Why Offer One?

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t All of that aside though, in terms of a broad-based program, it often is something that is lower cost to the company both in terms of the expense on the books as well as cash burn given that employees are actually contributing to the program itself instead of being given stock outright.

MORIARTY: David touched upon some of the reasons companies offer ESPPs. He further elaborates.

OUTLAW: I think that the main reasons are really two-pronged. So first is that it helps drive an ownership culture because people are actually buying the stock. So therefore, they have an interest in how that stock performs, which is good from an incentive alignment perspective. That's something that makes it very shareholder friendly.

Now, one knock that we sometimes hear on ESPPs is that if people are selling the shares pretty quickly after they purchase them that it detracts from the ownership culture. And that's partially true to some degree. But in my opinion, it misses the point because if you have one purchase leading right into the next, then the employee always has skin in the game. So it might not be compounding in the way that it would if they were to hold every single share, but they always have a reason to be paying attention to the stock price and driving performance.

In another sense, it can actually be beneficial that they don't have to hold on to it long-term to get the benefit of it. Because for example, if you have long-time employees who might already hold a lot of stock, that you're not playing against their need to diversify their wealth, for example. So the ownership culture is one of the key reasons to issue an ESPP.

The other one is simply that it makes a really attractive compensation and benefits package in this war for, that I think all companies are really seeing and feeling right now.

MORIARTY: David discusses the types of companies that usually offer ESPPs and if they are industry specific.

OUTLAW: Lots of different kinds of companies issue ESPPs. Most acutely, that is technology companies, usually on the West Coast where pretty much every company has any ESPP of some sort.

But even within that group, we see diversity, we see different types of companies that are issuing their ESPPs for different sorts of reasons. It's something where when a new employee comes on board, yes, HR gives them some sort of walkthrough of the ESPP.

But more importantly, it's something that their new colleagues are going to be talking to them about and encouraging them to participate in. And so it can be a part of the culture of a more mature company. But at the other end of the maturity spectrum, we very often see companies who are IPOing and decide to launch an ESPP alongside their IPO in order to give employees a chance to participate in that IPO price in a way that they might not otherwise have access to given various blackouts and restrictions and things like that. So we see diversity even within the technology space. But as I mentioned, it can be a really exciting part of the portfolio even for companies outside of that space. So for example, energy is another one that we see where ESPPs are a compensation tool that is resilient across the up and down cycles.

MORIARTY: David just discussed ESPPs in relation to IPOs, but can they also apply to SPACs?

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t OUTLAW: I guess I should be a little bit less specific in using the phrase IPO. I should say going public because between IPOs, direct listings, and SPACs these days, there seem to be a lot of roads that are leading to Rome. And with any of them, you can implement an ESPP that essentially kicks in on that first day of trading for the lookback price.

MORIARTY: David Outlaw discusses the different types of ESPPs and the way they differ.

OUTLAW: ESPPs are actually shockingly diverse, I think much so more in practice than stock options, for example. They're just different in ways that are unique to ESPP. So it's a little bit of its own language. So we can talk about five main levers with the design.

First is tax qualification under Internal Revenue Code section 423. If you're familiar with incentive stock options, that's IRC 422, so it's very similar guidance in that regard. Essentially, what it does is it says, if you design a plan within this fairly reasonable and broad set of boundaries, then your plan can be qualified. And if so, then your employees can get a capital gains tax treatment rather than ordinary income provided that they meet certain holding requirements.

Many, many U.S. plans are 423 qualified because it's a fairly easy way to increase the benefit of the ESPP, unless you're trying to do something sort of unique and potentially special with the design. So that's usually the first node in the decision tree of designing a plan.

From there, we go into our second design lever, which is how much of a discount you buy the stock for. So for a 423 qualified plan, that maxes out at a 15% discount that you're allowed to have. And indeed, 15% is the most common discount that we see in the market. And it's one of those probably path dependent things where because that was what the tax code allowed when it was written back in the 80s that many companies gravitated toward that. And so it's very much become the norm in that regard.

MORIARTY: Are there any exceptions?

OUTLAW: There are a couple of exceptions to that, that I should probably note. One is that some companies have a less exotic plan that is really just a matching stock purchase plan where they might say you're going to put some money in, we're going to match 25% of it, and then you're going to buy stock with that. Of course, a 25% match is effectively a 20% discount. That kind of a plan wouldn't have lookbacks, it wouldn't be 423 qualified, but we do see some plans that are just outside of this discount world entirely.

Then there is another category of practices around discounts where we see companies with just a 5% discount. Really that's another historical accident due to regulatory changes. So back in 2004 when FAS 123R was introduced that changed the accounting for stock options and by extension ESPPs as well, there was an exception that ESPPs would not have to be expensed on the P&L if the discount was 5% or less, and there were no lookbacks or other lucrative features.

The idea basically being that if a company wanted to just issue stock the traditional way with bankers that they would be paying at least 5% anyway, so it's not really compensatory to give that small of a discount. Now, those plans aren't very good benefit plans, they don't tend to have very high participation. But that is something that you do see; a lot of companies out there that have this semi dormant plan with just a 5% discount. But among companies who are trying to make a differentiated

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t play in their compensation and benefits package, 15% is far and away the norm.

Now, the third design lever is what's called a lookback. I've mentioned this a couple of times, it's that ability to buy at a discount from the lower of the beginning or the ending stock price at the end of the purchase period. And essentially what that is then is a call option. Now, not every plan has this certainly. But in technology, they generally do. It's in some of the other industries where we see a little more variation on this. This is a feature that adds a little bit of expense because you do have this optionality, but it adds a ton of value to participants.

MORIARTY: So what is the reason it adds so much value to participants?

OUTLAW: If you have no lookback, then you have a guaranteed gain of whatever your discount is. So let's say it's 15%. It can't go lower, but it also can't go higher. Because you're contributing a fixed amount of money, if the price goes up, you buy fewer shares, and you lock in 15% of your contribution as your gain no matter what. So even that's not a bad deal at all, right?

But the lookback is where it starts to get super fun and really a unique deal for employees. Because with the lookback that 15%, it's now simply the floor on your gain, and it can go up from there. So if the price stays flat or if it goes down, then you stick that 15% in the bank or your brokerage account, I suppose. But if it goes up, then you keep your original 15% and then you start stacking on top of it dollar for dollar for every increase in the stock price.

Now, the fourth main design lever is the length of the offering period and the purchase periods. So the purchase period, to go through some terminology here, is the length of time where you are having money deducted from your paycheck and set aside before a purchase occurs. So in the example that I've been using so far, that would be a six-month purchase period. Now, the offering period is something that can either be the same as the purchase period or it can be longer. And the reason that the offering period length matters is if you have more than one purchase per offering, you can have a longer runway for your lookback feature.

MORIARTY: David discusses another common design.

OUTLAW: Another common design is to have a two-year offering period with four, six-month purchases occurring during it. And again, that advantage is that run-up ability in the lookback feature. So by the time you get to that two year mark, you're 24 months in, you are looking back not six months, but 24 months all the way to the start.

There's the ability for the stock price to have increased very dramatically and therefore made a very, very lucrative benefit for employees. In terms of what is common with purchase periods and offering periods, this is another place where we do see something of a dichotomy.

So for companies where there is no lookback and it is just more of a simple discount or a match program, then more frequent is common, like quarterly or something like that. There's no real upside or downside one way or the other, so it's mostly balancing the administrative burden of frequent purchases against the liquidity for the employees.

Now, if there is a lookback, the most common is to have six months offering with a single purchase. But that two-year plan with the four, six-month purchases is increasingly common where companies are trying to differentiate their ESPP and make it a richer benefit.

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t That's actually a good segue since those longer offerings often pair with our fifth design lever, which is reset or rollover mechanisms. And this is what companies use when they're trying to make their plan as advantageous and differentiated as possible.

So to explain these features, let's dive a little bit deeper into those two-year plans. The advantage again is clear, you have a longer runway for the price to increase, and your lookback is still anchored back to the price at the very beginning of the offering. But what about the downside, right? If the price drops in the first six months, it wouldn't be hard to take advantage of the lookback unless there's a quick recovery or you're stuck underwater. And that's where the reset comes in. It says that, okay, if the purchase price dips below the offering price, you make that lower of purchase like you normally would. But right after that, the offering price that's your anchor for the lookback, it resets to that now lower stock price for the remainder of the offering. And that way it's like a downward ratchet that always keeps employees in the most advantageous position.

MORIARTY: David gives us his insights as to available options when a company initially chooses a design plan and then several years later a more advantageous plan comes along that could attract talent even more. Can a company switch and would that be a burden for the company? How would employees be affected?

OUTLAW: It actually is in line with a lot of what we've been seeing over the last five years or so, which is ESPPs have historically been on sort of a pendulum where if you go back to the 90s, these very, very rich plans, even with resets and things like that were fairly common.

Then when the accounting rules changed in the early 2000s, a lot of companies dialed it back because they were afraid of the P&L hit.

And then after the financial crisis when the economy started booming again and the war for talent got more and more acute, companies started re-investing, they started seeing their ESPP as something that they could use as a differentiator. And so what we saw was a lot of companies starting to go from a less lucrative plan to a more lucrative plan.

It's actually a fairly easy thing to do. Most ESPPs, the actual legal plan documents, first of all, they're very easy to have shareholder approved. We'll talk about that a little bit more later.

But second of all, they usually give the company pretty good latitude in terms of what specifically they do with the plan that they decide to implement. There's this umbrella that allows the company to make decisions, and the company can then make those decisions. So that process, you want to model out what the cost differences would be, of course. But that's the main challenge for the company is making sure that they understand what it's going to do from a cost perspective.

Then from the employee perspective, you can't change an offering midstream typically, but they're always rolling off. What you can do is you can just once the next offering ends, roll them into the new plan.

And really, it's an employee communication and education question like so many things are just to make sure that they understand the benefit that they're getting with the switch.

MORIARTY: There is certainly a lot of design variety but outside the main terms, David discusses other ways the plans are different.

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t OUTLAW: One common category of ways that plans are going to differ from one another is participation rules. For example, how much of somebody's pay are they allowed to contribute to the ESPP? Is that capped at 5% or 10% or 15% of somebody's compensation? That's a decision companies have to make.

There's also a related decision of what kind of compensation counts. So base pay is always there, but what about bonuses? What about commissions? Things like that are variable. You see more variation with companies there. The ability of people to change the degree to which they're participating is another way that it varies.

So for example, increasing or decreasing how much of your paycheck you're having deducted is something where we see variation. And the reason we see variation there is because of the accounting ramifications, which we'll talk about a little bit later.

But increasing your contributions is something that is actually a modification for accounting. So companies try to limit people's ability to do that either by prohibiting entirely, except for between offerings, of course, or by limiting it maybe to one time that it can happen mid period of a certain offering. Decreases, sometimes it's just as limited, sometimes you see more ability to do that because there is no onerous accounting or administrative burden to that. In a similar vein, we have withdrawals. And so can somebody either reduce their contributions down to zero and/or withdraw from the plan entirely and get their money back? Obviously, in case of termination, that's something that's universal. But outside of that, it's something that companies have to weigh the pros and cons of the administrative burden there again.

And then other things like cash infusion. So does somebody only have to prospectively have pay deducted from their paycheck or can they write a check to fill up their account for the ESPP contribution? That's where we see some variation there. That latter one is a little more rare, and we'll talk about why in a little bit when we talk about the accounting.

On a related note, auto enrollment is another common feature that we see these days, especially when companies are going public where they will automatically enroll employees in the ESPP and then give them the opportunity to opt out. But that way nobody misses the opportunity due to whatever reason to participate in that initial offering that's happening.

Then outside of that, we see international differences quite a lot, of course. And obviously, you'll need to talk to international securities counsel because it's driven by different global laws. But for example, you'll very often see sub-plans for places where the types of plans are more limited than what are allowed in the U.S.

MORIARTY: David Outlaw mentioned certain tax qualifications. He further elaborates.

OUTLAW: The basic gist is that as long as you stay within some basic design bounds, employees can get favorable tax treatment. And the design bounds are pretty easy to meet for the most part.

As I mentioned, only being open to employees, not being transferable. The plan has to be approved by shareholders, which is usually pretty noncontroversial.

Then eligibility, basically it has to be broad based and non-discriminatory. You have to exclude anyone who owns more than 5% of the company. If you want, you can exclude new hires, part-timers, seasonal workers, and highly compensated employees. And then anyone who is eligible for the plan has to have equal rights and privileges under the plan.

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t Then on the economics of the plan itself, essentially the discount can't be higher than 15%. The term can't be more than 27 months for an offering if there's a lookback or five years if there's no lookback. Then there's a $25,000 cap on how much stock can be purchased per person.

So assuming you meet those, the plan is tax qualified. What that means is the employee basically gets tax treatment similar to ISOs, Incentive Stock Options, if you're familiar with those.

So if they hold the stock without selling for at least two years from the offering date and one year from the purchase date, then the tax upon sale is entirely capital gains. If they sell before that point, it's a disqualifying disposition.

They get taxed then at ordinary income for the spread at purchase, the difference between what they paid and what the stock was worth. Then its capital gains or losses for any subsequent movement from there.

And then of course, there's a need for the company to track all of this as well, just like with ISOs. If the employee has a qualifying disposition, so they've held it for the two years, then there's no income ever recognized, no ordinary income on their tax return. And therefore, the company doesn't get to deduct anything on its own taxes for compensation costs because there was no compensation or no income, I should say. But if the employee has a disqualifying disposition, then that spread does get recognized as ordinary income by the employee, and therefore the company gets a deduction in that amount.

MORIARTY: The key principle with ESPPs is to value each component part. David discusses how fair value is estimated.

OUTLAW: If it's a simple discount plan, then the value is going to be simple. It's your percent discount multiplied by the stock price. So if the price is $100 and the discount is 15%, then the fair value is $15.

And the employee, they're contributing the other $85 themselves, so that's not compensation and not something that you therefore need to expense. Now, if you pay a dividend, there's a small wrinkle to add in there to slightly haircut for the dividends that are missed during the purchase period. You might pay two dividends during the six months, for example.

Now, the next piece to look at is if you have a lookback feature allowing you to buy at the lower of the beginning or ending price. So there, as you might guess, it is akin to an option.

Basically, if the price goes up, I can still buy it at today's price. So there's an at the money call option, and you can just use Black-Scholes for that. And fortunately, you have a fixed term.

Everything else from stock-based compensation accounting applies in terms of the way that you use Black-Scholes. But there's also a put option for most plans, which is a little less intuitive. And it's because if your price goes down, you can actually buy more shares with your fixed contribution so that your dollar gains are maintained.

In other words, if the price goes down, your payout stays flat, and that's a put option. So putting those pieces together, let's say for illustration, it's a 15% discount again. So you've got one, the discount valued at 15% of the stock price, two, an adjustment for forgone dividends, three, 85% of a Black-Scholes call option. And four, it is 15% of a Black-Scholes put option.

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t So you sum those four pieces together, and that's your value. So the question we often get is what actually drives the resulting value then. And the main thing honestly is the terms of the plan.

SURRAN: ASC-718 Compensation-Stock Compensation has a section that specifically discusses Employee Stock Purchase Plans that provides clear authoritative accounting guidance.

It offers several examples covering different features and how they are accounted for.

According to the guidance, you have a fair value at the offering date and you expense that over the purchase period. Similar to other stock-based compensation, you can analogize the grant date to the offering date and the vesting period or requisite service period over the purchase period.

MORIARTY: David Outlaw discusses in further detail the expense model and how it works.

OUTLAW: The first piece of it is fundamentally how many shares do you apply that fair value to that we just talked about? That's because this isn't like an RSU or a stock option where the number of units is actually a part of the contract, and you don't actually know at the beginning how many shares are actually going to be purchased.

Capital so what you need to do at the time of the offering is to estimate the number of shares at that point. And the way that you do that, it's going to be a division problem. So your numerator is your estimated contributions.

The specific way that you might come to this is going to vary a little bit from company to company, but you want to have a process that's set that is auditable, that is controlled and repeatable. Essentially what you want to do is say the percentage that somebody is contributing and then what their expected pay is over the length of the purchase period. And that will give you an estimated total dollar value that you expect to see in their account when the purchase actually occurs.

And then the denominator of that is the purchase price if it happened today. So continuing our example, that would be 85% of the stock price at the time of the offering.

That will be our estimated number of shares. We'll apply the fair value that we computed to that, and then there'll be some true-ups at the end and potentially some adjustments along the way that we'll talk about here. The next upfront consideration though is the classification, is this an equity or a liability? And that's actually something that depends on the design.

So for most of the designs that we've talked about where you have things like lookback features that make it option like, those are equity classified. And that means that you get the fixed accounting based on the grant date fair value just like other forms of equity awards.

But if it's a pure discount plan with no lookback, then technically it is a liability. That's because it's a fixed dollar amount, the contributions being settled by a variable number of shares. So it's a classic liability.

MORIARTY: David discusses exceptions to the accounting model and remeasurement triggers.

OUTLAW: One type of remeasurement, for example, would be, true mark to market where you're actually having to revalue the plan each reporting period. The typical way that you end up in that situation is by not having an

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t accounting grant date. And the most common way of getting to that point is allowing late cash infusions where somebody can maybe participate in the plan at a very low level.

Then when it comes time for the purchase, they can say, "Oh, this is going to be a very lucrative purchase, I'm going to write a $25,000 check and max out my contributions in order to get as big of a gain as possible." And that would result in a delayed accounting grant date if that sort of thing is allowed because you don't have a mutual understanding of the key terms and conditions, which is of course, that critical piece of ASC 718 for having a grant date because basically if the employee can just change the game right at the very end, then there's no mutual understanding flowing back to the company. Therefore, no account grant date. Therefore, mark to market and having to revalue that each period until it's actually settled or until their ability to do that cash infusion goes away.

But aside from that, primarily the things that would cause variability are modifications. And there are two primary common drivers of modifications.

So one is resets or rollovers where mid offering you have a purchase where that lookback anchor price decreases. The other one is changes, specifically increases to the withholding rate.

And so if somebody says, "I want to, instead of deducting 5% of my paycheck, I want to deduct 10% of my paycheck." Then that is also accounted for as a modification to the plan, to the deal essentially.

SURRAN: There are two main reasons ESPPs are considered shareholder friendly. First, they drive ownership culture by aligning the incentives of employees with those of shareholders. Second, they are P&L and cashflow friendly as companies are effectively issuing more equity and less cash.

As a result, ESPPs are much less contentious than any other stock plan when it comes to getting approval from shareholders. David Outlaw, elaborates further as to governance and shareholder considerations and how the pandemic may have changed the momentum.

OUTLAW: If we think about ISS, Institutional Shareholder Services, who's very influential in proxy voting matters, if you've had any sort of exposure to them with regular equity plans, you know that there's this huge complex equity plan scorecard, they call it, with all of these moving parts and weightings and different features and restrictions on what you can do with those plans. And it's this very complex process to actually get those passed with your shareholders. ESPPs are nothing like that at all. If you look at the ISS guidance there, they say that if it's a qualified plan, then we are going to vote yes on it as long as it's less than 10% of your total outstanding shares. And if it's a non-qualified plan, essentially we'll have substantially similar terms there, for example, up to a 25% match with no lookback. So they're very non-controversial and easy to get past, and shareholders generally tend to like ESPPs.

MORIARTY: David Outlaw concludes our segment on employee stock purchase plans and leaves us with his parting thoughts.

OUTLAW: Educate yourself like you're doing now, your service providers who work in stock-based comp might also be able to help.

But in any event, because these are a new type of plan for your company, it probably does seem like a lot at first. But the concepts

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t quickly become familiar and intuitive compared to other parts of ASC 718. And it's the kind of thing that the further you get into it, the more you'll be able to realize that it's very implementable and not something that you'll have to create entirely from whole cloth.

The other piece of advice I would have is to get a seat at the cross-functional table early because while there's no reason to be afraid of these plans, it will impact your world. And there's no understating that. There are two main benefits to making sure you have a seat at that table.

The first one is that you can bring your knowledge and your analytical power to bear in making sure that there's a cost benefit for any decisions. Because it might be that your colleagues in HR or stock administration are trying to decide between a plan A and a plan B that they think are approximately equal in terms of the benefit. Well, it may be that with your knowledge of the accounting for these plans, you realize one is much more costly either in terms of P&L or in terms of process and support that you might need. And that might be able to sway the design toward A or toward B depending on which one is more economical.

The second way that it's favorable to have a seat at that table is just so that you don't get surprised because unfortunately, we still do see cases where one of these shows up in the proxy and accounting finds out about it then and is then scrambling to stand up processes, to stand up controls. And you never want to be scrambling to do that because you want to be able to do it thoughtfully and then advance and engage the right stakeholders internally and externally. So make sure you get a seat at that cross-functional table.

From there, the thing that you have to do is model out different scenarios so that you can avoid surprises because ESPPs can admittedly sometimes not be totally intuitive. So you want to be able to flex assumptions, both in terms of the design of the plan, but also the participation rate and how much people contribute to it. And how that might vary from one level to the next, and how that's going to act in up stock price scenarios versus down stock price scenarios. And so being able to just play those out will help everybody avoid a surprise down the line if something doesn't act the way that they might have thought that it would.

What that also allows is for you to look at both sides of the ledger, the costs and the benefits. You can say, okay, if our cost is going to on average be X for this level of participation, is the benefit that actually accrues to employees, is that going to be higher or lower? For example, it might be with the lookback plan that you have a lower benefit than costs in down markets and a much higher benefit than costs in up markets. And it's good to have some sense of the scale there. The final thing that modeling things out does is it allows you to ferret out all the little moving parts because there are new moving parts with the ESPPs compared to other stock-based compensation. And being able to get granular allows you to make sure that you're totally comfortable with those things before it goes live.

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Segment Two

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two 2. Accounting & Valuation of SPACs

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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

“Four Key Takeaways from The SPAC Conference 2021”

“Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”)”

See page 2–12.

See page 2–19.

36 minutes

Special purpose acquisition companies, SPACs, also known as “blank check companies” raise money but are listed on an exchange before they even own any assets. Their goal is to acquire a privately held company within two years. These are both good enough reasons to be on the SEC’s radar. The SEC not only looks closely at filings and disclosures by SPACs in an effort to protect the public interest, but also, in April 2021, issued new guidance on the treatment of SPAC warrants with neither previously issued proposals nor a comment period. This was an uncharacteristic move that caught financial professionals by surprise. Zac McGinnis, managing director at Riveron Consulting and Josh Schaeffer, director at Equity Methods, provide a more in-depth discussion on SPACs and their execution.

Upon successful completion of this segment, you should be able to: l Understand the new accounting treatment of SPAC warrants

and its impact on financial statements, l Identify the differences between SPAC warrants and de-

SPAC transactions, l Recognize some of the considerations with respect to

financial statement restatement, and l Determine the difference between each of the three

simulation models and best one to use for valuation.

Expiration Date: November 6, 2022

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A. New Guidance on SPACs

i. SPAC warrants to be recorded as a liability l Issued recently for SPACs l Have gone through the acquisition

process b Acquired companies listed as

public l Or company acquisition in

progress

B. Impact of New Guidance on SPACs

i. Tapping brakes on volume

ii. Market pause l Restatement of previously issued

financial statements

iii. Reassessing strategies l Warrants l De-SPAC

iv. Navigating through guidance and valuations

C. SPAC Sponsor Challenges

i. SPAC classification l Liability l Equity

ii. Business objective

iii. Formation & jurisdiction

iv. SPAC’s business purpose

v. Timing

D. Considerations When Deal Window Is Open

i. Liability classified SPACs l Economic disadvantages

b Target b De-SPAC b Sponsor

ii. Timing delays l Liability vs equity

iii. Economic consequences l Modeling by financial advisors l Investor considerations

I. New SEC Guidance for SPACs

Outline

A. Types of Warrants

i. Public

ii. Private

B. Private Warrants

i. Additional capital raised in the total SPAC IPO

ii. Sits as a liability

iii. Incentivizes additional investors

C. Public Warrants

i. Given for free

ii. Historically classified as equity

iii. Converts into a half or a third of a share

iv. Incentive to participate in the de-SPAC

II. SPAC Warrants: Definition and Types

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A. Reasons for Interpretive Guidance

i. Cash settlement provisions of warrants l Classified as a liability l Prove its equity l Likelihood of events

ii. Accounting & presentation of deferred offering cost

B. Considerations of Restating Financials

i. Material misstatement

ii. Size of misstatement l Big R, little R, no R

C. Clarifying the “Rs”

i. Big R l Refile past 2 years of annual

financial statements l Balance sheet & non-debt

quantitative metric considerations

l Requires agreement from all parties

ii. Little R l Mistake is not sizeable

l No impact on decision making process

l Revised historical financial information in subsequent quarter

D. Impact of Restatement – Three Scenarios

i. Manageable l Revisions on 12/31/20 10K l Change reflected in Q1 filing

ii. Significant impact l First S-4 registration filing

during de-SPAC l Change de-SPAC at the restate

iii. Challenging l De-SPAC took place in 2020

and prior l Assess the number of years a

restatement is needed l Impacts de-SPAC & filings for

several periods

IV. SEC on Accounting Treatment of SPAC Warrants

A. Finding a Target Company

i. Acquisition process begins l Letter of intent

ii. Due diligence

iii. De-SPAC transition l Merger formally announced

iv. SEC filings

B. De-SPAC Transaction

i. Legal business combination l Prior to the 24-month SPAC

expiration

C. SPAC Warrants vs de-SPAC

i. SPAC warrants l Issued at the SPAC IPO l Limited value until the de-

SPAC occurs l Limited life expectancy

ii. De-SPAC l Series of conversions

b Warrant holder b Equity holder

III. The SPAC and de-SPAC Process

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A. Volatility Periods

i. SPAC looks for a target company l Acquire and take public

ii. Acquired company is publicly traded l Operating company

B. SPAC Warrant Features

i. Variable l 5 years after a de-SPAC

transaction

ii. Right to call the warrants l Force early exercise

iii. Element of the unknown

B. Simulation Model Comparison

i. Black Scholes l Consistent results l Doesn’t work with call

provisions

ii. Lattice l Can be calibrated to handle call

provisions l Used in employee stock options

iii. Monte Carlo l Random trials breakdown l Change volatility mid-stream l Handles probability of failure

C. Valuing Warrants

i. At issuance l Understanding the value of the

portfolio

ii. At the start of trading l Two months after SPAC IPO l Estimated volatility

•. Adjust model for public & private warrants

V. SPAC Volatility and Value

A. Zac McGinnis’s Final Thoughts

i. Choosing liability classification l Refresh valuation l Plan and assess

ii. Sponsors contemplating l Doing a SPAC IPO l Have time to

b Look at legal terms b Work with auditors,

accounting advisors and bankers

“So, it will be interesting to see what those legal terms will look like and what the SEC will accept…”

— Zac McGinnis

B. Josh Schaeffer’s Final Thoughts

i. Look at warrant agreements l Classification & value

ii. Understand the valuation

VI. Final Thoughts Looking Forward

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1. What is the SEC’s new guidance on the treatment of SPAC warrants and what impact has it had on SPACs? How has the SEC’s new guidance impacted your organization?

2. What are some of the biggest challenges sponsors are facing when they form a SPAC and how should companies think about capturing the deal window? What challenges is your organization facing in determining whether it will go to market as a liability or equity classified SPAC?

3. What are the types of SPAC warrants?

4. What is a de-SPAC transaction and how do they differ from SPAC warrants?

5. When do SPACs or the combined company following a de-SPAC have to restate financial statements? How does the impact of restatement affect your organization?

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2. Accounting & Valuation of SPACs

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

“In this segment, Zac McGinnis and Josh Schaeffer provide an in-depth discussion on SPACs and their execution.”

l Show Segment 2. The transcript of this video starts on page 2–19 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 2–7 to 2–9. Additional objective questions are on pages 2–10 and 2–11.

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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6. What factors should be considered regarding volatility periods, the initial SPAC price, public call provisions, and additional features with respect to SPAC warrants? How do these factors impact your organization?

7. What are the differences between the three simulation models and which is the best one to use? Which model does your organization use, and why?

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sDiscussion Questions (continued)

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1. What is the SEC’s new guidance on the treatment of SPAC warrants and what impact has it had on SPACs? How has the SEC’s new guidance impacted your organization? l SPAC warrants to be recorded as a

liability on the balance sheet: b All warrants that have been issued

recently for SPACs b All warrants have already gone

through the acquisition process b Companies listed as public, as

well as those that are going through that progress

l Impact of new guidance on SPACs b Assisted in tapping the brakes

with respect to volume b Paused the market

v Restatement of previously issued financial statements

b SPACs are reassessing their strategy to go to market around the warrant issue and on the de-SPAC side

b SPACs need help navigating through the guidance v Valuations needed for public

and private placement warrants to update financial statements

l Participant response based on personal/organizational experience

2. What are some of the biggest challenges sponsors are facing when they form a SPAC and how should companies think about capturing the deal window? What challenges is your organization facing in determining whether it will go to market as a liability or equity classified SPAC? l Determining whether or not they

want to go to market classified as liability or equity: b Determining the business

objective b How it will be formed b What jurisdiction will it be based

l What will be the business purpose b Should it focus on a particular

industry? l How timing has been impacted l When the deal window is open think

about whether as a liability classified SPAC are there economic disadvantages for: b Target b De-SPAC b Sponsor

l Timing delays b Will an opportunity be missed by

partnering up with a liability classified SPAC versus an equity classified SPAC?

l Economic consequences of partnering with a liability classified SPAC: b Make sure financial advisors are

modeling it on that basis b Considerations of investors –

there is still a lot of confusion l Participant response based on

personal/organizational experience

3. What are the types of SPAC warrants? l Private warrant

b The company raises additional capital that sits in a trust account that is used as part of the purchase consideration for that target company

b Sits as a liability because it has cash settlement features

b It is a way to incentivize additional investors to get into the deal on the front end

l Public warrant b Effectively given for free b Historically classified as equity,

but now could be a liability b Converts into a half, or a third of

a share later b An incentive to participate in the

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2. Accounting & Valuation of SPACs

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4. What is a de-SPAC transaction and how do they differ from SPAC warrants? l De-SPAC transaction

b A short term for the ultimate business combination

b The actual legal business combination that happens prior to the 24-month SPAC clock expiring

b A way in which a private company can go public without having to do a traditional IPO

l SPAC warrant b Issued at the SPAC IPO in month

one b Does not have a lot of value until

the de-SPAC occurs b Life is based on the timing of the

de-SPAC l De-SPAC

b Series of conversions in which warrant holders either: v Continue to be warrant

holders, or are v Now equity holders in the

newly formed, or newly merged entity

5. When do SPACs or the combined company following a de-SPAC have to restate financial statements? How does the impact of restatement affect your organization? l When there is a material

misstatement in previously issued financial statements b Go through assessment of big R,

little R, no R l Big R

b Where you have to go back and refile the last two years of annual financial statements

b Rule of thumb is that if misstatement is 25% of pre-tax income for the last year, it is expected to be a big R

b Balance sheet and non-debt quantitative metrics to consider

b Consult with national office to all agree that it is big enough to go back and refile audited financial statements from prior periods

l Little R b There is a mistake, but not so big b Investors are still making wise

decisions on the previously issued financial statements

b Can file their next quarter with the historical information revised

l No R b So small, a sentence can be put in

a footnote b Not big R or little R

l Participant response based on personal/organizational experience

6. What factors should be considered regarding volatility periods, the initial SPAC price, public call provisions, and additional features with respect to SPAC warrants? How do these factors impact your organization? l Volatility periods

b First is when a SPAC is looking for a target company to acquire and take public

b Second is after the acquisition, when the company is no longer a target, but is a publicly traded company (an operating company)

l SPAC warrant features b At their core, they operate like

plain vanilla warrants or options you might see in the market

b SPACs do not pay dividends, so you do not have to worry about that

b Term is variable v Typically goes until five years

after a de-SPAC transaction v Term can be short, or longer

with a two-year window of when the de-SPAC occurred su

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Suggested Answers to Discussion Questions (continued)

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b A right for the company to call the warrants and force early exercise v Almost always worded to say

that if the stock price goes above $18 for 20 out of 30 days, the company has a right to offer a penny to buy back the warrants unless the holder exercises

b Consider element of the unknown v We do not know what kind of

company we are looking at b Private warrants might also be

subject to a call l Participant response based on

personal/organizational experience

7. What are the differences between the three simulation models and which is the best one to use? Which model does your organization use, and why? l Black Scholes

b The typical model used for valuing warrants

b Not the most advanced model, but especially for financial reporting, it gets results that are consistent with the terms of most market traded warrants and options

b Special factors, such as a call provision, do not fit into this model

l Lattice b Can be calibrated to handle call

provisions b Model used a lot in employee

stock options

l Monte Carlo b Breaks down formulas in Black

Scholes or lattice models into random trials

b Can change the volatility mid-stream

b Can put in a probability of failure directly into the model

b The various factors going in allow us to get a more useful value v Takes into accounts all the key

features v Allows for the distinction

between the conditions for the public warrants and the private warrants

l Participant response based on personal/organizational experience

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sSuggested Answers to Discussion Questions (continued)

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1. According to the new accounting guidance, all warrants that have been issued recently are to be recorded as:

a) equity

b) a liability

c) an asset

d) revenue

2. The two types of SPAC warrants are:

a) equity and private

b) municipal and public

c) long-term and short-term

d) private and public

3. A de-SPAC transaction differs from SPAC warrants in that:

a) it is issued at the SPAC IPO

b) its life is based on the timing of the SPAC

c) it is a series of conversions

d) is has a lot of value up until the SPAC occurs

4. Under a big R restatement, how many years of previously issued financial statements are refiled?

a) 2

b) 3

c) 5

d) 7

5. The term of a SPAC warrant is typically:

a) two years after a de-SPAC transaction

b) three years after a de-SPAC transaction

c) five years after a de-SPAC transaction

d) seven years after a de-SPAC transaction

6. Which valuation model gets results that are consistent with the terms of most market traded warrants?

a) Black Scholes

b) comparables

c) lattice

d) Monte Carlo

7. One of the first takeaways from The SPAC Conference 2021 was:

a) SPACs are almost obsolete in the capital markets

b) SPACs have gained trust and credibility among investors

c) SPAC activity going forward is expected to be double that of 2020/2021

d) SPAC transaction activity increased dramatically due to regulatory intervention

8. An area of concern related to incentives in a SPAC transaction is that:

a) SPAC sponsors may be providing forecasts that are unsupportable

b) company management may be investing in a product that they do not fully understand

c) underwriters may face risk by rushing to select the wrong deal

d) assets be overlooked due to the increased levels of deployed capital

9. An equity linked financial instrument must be considered indexed to an entity’s own stock to qualify for:

a) liability classification

b) asset classification

c) equity classification

d) off balance sheet classification

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 2–12.

Objective Questions

2. Accounting & Valuation of SPACs

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10. After considering the recent SEC statement, a registrant that concludes there is an error in previously-filed financial statements should:

a) evaluate the materiality of the error

b) immediately restate previously-issued financial statements

c) have its previously-issued financial statements reaudited

d) conclude that there are internal control deficiencies

Objective Questions (continued)

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Self-Study Option

Reading (Optional for Group Study)

FOUR KEY TAKEAWAYS FROM THE SPAC CONFERENCE 2021

Sasha Morozova Zac McGinnis Greg Carlson June 30, 2021 Source: https://riveron.com/posts/four-key-takeaways-spac-conference-2021/

Amidst the capital markets boom of special purpose acquisition companies (SPACs), Riveron’s team participated in The SPAC Conference 2021. The event convened sponsors, investors, target companies, and partners abuzz with talks of current challenges, innovative ideas, and projects. Ultimately, there are no signs of slowdown for this popular alternate method for accessing the public capital markets. Here are four key takeaways from the conference.

TAKEAWAY 1: SPACs have gained popularity and are a vehicle with staying power.

Although SPACs have been around for decades, the past year and first quarter of 2021 have become a remarkable time for this capital markets vehicle. As this path has

become increasingly prevalent, today’s SPAC sponsors rarely need to explain to target companies what a SPAC is or how it works. Even with a slight slowdown after the presidential election, conference participants noted that the market surged with activity in 2021 with nearly 350 SPAC IPOs, many occurring in the first quarter.

The surge of popularity of SPACs was initially paved by the pandemic which, near the end of the first quarter of 2020, temporarily froze the IPO window. Low interest rates, continuous volatility of the traditional IPO market, and investors’ appetites for new growth opportunities further fueled popularity of SPACs throughout the early Q2 2021. In the second quarter of this year, the SPAC market shifted dramatically, with many SPACs trading near or below the value of the cash value in their trust accounts. The shift happened in part due to the market being oversaturated with more than 400 already public SPACs searching for targets to find deals. (Related article: the “SPAC clock” is a common challenge in deal success.) The

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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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situation was further exacerbated by a statement released in April by the Securities and Exchange Commission (SEC) regarding warrant accounting, causing many active SPACs to revisit the accounting for warrants, which sometimes delayed deal activity for about a month.

Despite the slowdown of SPAC transaction activity due to regulatory intervention and other factors, the fundamentals of the SPAC market remain strong. Throughout the conference, participants noted on multiple occasions that—although SPAC activity going forward may not be able to measure up to the level of activity observed during 2020 and first quarter of 2021—the SPAC product has become vital and central to the capital markets. SPACs have gained trust and credibility among investors, and the vehicle is here to stay.

TAKEAWAY 2: Many parties are at the SPAC transaction table, so incentives must be carefully navigated.

A conference session on SPAC incentive structures session highlighted that the SEC recently outlined three areas of concern related to incentives in a SPAC transaction: first, investors may be investing in a product that they do not fully understand; second, sponsors may face risk by rushing to select the wrong deal as the “SPAC clock” runs out; and last, assets might be overbid due to the increased levels of deployed capital.

In SPAC scenarios, three major players might be faced with misaligned incentives, including: (1) SPAC sponsors, with a real incentive to get the deal done; (2) company management, with the incentive to provide forecasts and other disclosures that might be unsupportable or unable to be validated adequately; and (3) underwriters, facing an incentive to push through the deal so that significant compensation is not deferred.

When discussing incentive structures, conference panelists emphasized the importance of establishing and maintaining market-based solutions that help alleviate the misalignment of incentives, and solutions should provide adequate reward to the parties involved in SPAC transactions.

Discussion also underscored the importance of appropriate compensation programs to attract and retain talent of a target in the post-merger period.

TAKEAWAY 3: For investors to understand SPAC deals, disclosures are paramount.

A panel of experts, including Riveron’s Zac McGinnis, highlighted the importance of clear disclosures when investing in a SPAC or de-SPAC company. Retail investors especially need to understand the economics of the securities that could potentially dilute the value of public stock after a de-SPAC transaction. Expert discussion centered on a few key themes:

The importance of PIPE for raising capital

Private investment in public equity (PIPE) entails selling public company shares to select private investor or group of investors, and it has become significantly more important in helping SPACs raise additional capital to close a transaction with a target company. Raising PIPE-related commitment is critical to success, and this factor was frequently discussed as the driver for turning around many previously unsuccessful transactions, particularly when the cost of acquiring a target company is greater than the available funding in a trust account of a SPAC.

An increased focus on deal terms simplicity

Legal and deal complexity concerns were expressed consistently during the conference, even to the point where several practicing attorneys had difficulty understanding and articulating the purpose of various historically accepted and carried-forward agreements, such as the warrant agreement that is currently being re-examined in some cases given the SEC’s statement issued in April, and related interpretations. Overall, success depends on a shift to deal term simplicity to facilitate smoother transaction timing and to make it easier to avoid commonly misunderstood issues.

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Emerging perspectives on warrant accounting and deal impacts

Regarding the SEC’s April 2021 statement on warrant accounting, rule interpretation guidance is emerging as a hot topic for investors and their advisory teams. Contributing to the various perspectives of the panel, Riveron experts have observed a recent pattern for SPAC teams deciding to get to market quickly and conclude on liability treatment; a handful of these teams have decided to update their warrant agreement for equity classification. The economic or deal ramifications will be revealed over time when the de-SPAC process occurs for those sponsors that have elected liability classification.

TAKEAWAY 4: The operational requirements of being public are real, and companies must be appropriately equipped with the right processes, technology, and capabilities.

Most SPAC target companies lack the capabilities and infrastructure necessary to operate effectively as a publicly traded company. Establishing a base level of infrastructure and capabilities will help a target company differentiate itself to a SPAC and position the organization to scale effectively, minimizing incremental sales, general, and administrative (SG&A) costs as it grows. Priorities for establishing public company readiness vary by organization, but for many small and medium-sized organizations, the following areas often require the most focus:

l Implementing an enterprise resource planning (ERP) system that is public company ready, transitioning from a limiting “QuickBooks” type environment.

l Formalizing core accounting processes to be able to close the books efficiently and report results externally in a timely fashion.

l Enhancing the ability to plan and measure the performance of the business by establishing basic key performance indicators (KPIs) and metrics, planning processes, and management reporting methods.

l Upskilling existing team members or hiring new team members that have the requisite capability to meet public company requirements.

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John Coates Acting Director, Division of Corporation Finance Paul Munter Acting Chief Accountant April 12, 2021 Source: https://www.sec.gov/news/public-statement/accounting-reporting-warrants-issued-spacs

Introduction[1] In a recent statement, Acting Chief Accountant Paul Munter highlighted a number of important financial reporting considerations for SPACs.[2] Among other things, that statement highlighted challenges associated with the accounting for complex financial instruments that may be common in SPACs. Additionally, CF staff also issued a recent statement[3] highlighting key filing considerations for SPACs.

We recently evaluated fact patterns relating to the accounting for warrants issued in connection with a SPAC’s formation and initial registered offering. While the specific terms of such warrants can vary, we understand that certain features of warrants issued in SPAC transactions may be common across many entities. We are issuing this statement to highlight the potential accounting implications of certain terms that may be common in warrants included in SPAC transactions and to discuss the financial reporting considerations that apply if a registrant and its auditors determine there is an error in any previously-filed financial statements.

Accounting Considerations

Indexation

U.S. Generally Accepted Accounting Principles (“GAAP”) includes guidance that entities must consider in determining whether to classify contracts that may be settled in its own stock, such as warrants, as equity of the entity or as an asset or

liability.[4] Evaluation of this guidance requires an evaluation of the specific terms of the contract and also of an entity’s specific facts and circumstances.

An equity-linked financial instrument (or embedded feature) must be considered indexed to an entity’s own stock in order to qualify for equity classification.[5] While many instruments include a fixed strike price or a fixed number of shares used to calculate the settlement amount, other instruments may include variables that could affect the settlement amount. Such variables do not preclude a conclusion that the instrument is indexed to an entity’s own stock if the variables would be inputs to the fair value of a fixed-for-fixed forward or option on equity shares. To assist in an entity’s evaluation, GAAP includes a list of such inputs.[6]

We recently evaluated a fact pattern relating to the terms of warrants that were issued by a SPAC. In this fact pattern, the warrants included provisions that provided for potential changes to the settlement amounts dependent upon the characteristics of the holder of the warrant. Because the holder of the instrument is not an input into the pricing of a fixed-for-fixed option on equity shares, OCA staff concluded that, in this fact pattern, such a provision would preclude the warrants from being indexed to the entity’s stock, and thus the warrants should be classified as a liability measured at fair value, with changes in fair value each period reported in earnings.

Tender Offer Provisions

GAAP further includes a general principle that if an event that is not within the entity’s control could require net cash settlement, then the contract should be classified as an asset or a liability rather than as equity.[7] However, GAAP provides an exception to this general principle whereby equity classification would not be precluded if net cash settlement can only be triggered in

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STAFF STATEMENT ON ACCOUNTING AND REPORTING CONSIDERATIONS FOR WARRANTS ISSUED BY SPECIAL PURPOSE ACQUISITION COMPANIES (“SPACS”)

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circumstances in which the holders of the shares underlying the contract also would receive cash. Scenarios where this exception would apply include events that fundamentally change the ownership or capitalization of an entity, such as a change in control of the entity, or a nationalization of the entity.[8]

We recently evaluated a fact pattern involving warrants issued by a SPAC. The terms of those warrants included a provision that in the event of a tender or exchange offer made to and accepted by holders of more than 50% of the outstanding shares of a single class of common stock, all holders of the warrants would be entitled to receive cash for their warrants. In other words, in the event of a qualifying cash tender offer (which could be outside the control of the entity), all warrant holders would be entitled to cash, while only certain of the holders of the underlying shares of common stock would be entitled to cash. OCA staff concluded that, in this fact pattern, the tender offer provision would require the warrants to be classified as a liability measured at fair value, with changes in fair value reported each period in earnings.

The evaluation of the accounting for contracts in an entity’s own equity, such as warrants issued by a SPAC, requires careful consideration of the specific facts and circumstances for each entity and each contract. OCA is available for consultation on accounting and financial reporting issues, including relating to an entity’s specific fact pattern on issues similar to those described above or on other instruments and accounting issues.[9]

Registrant Filing Considerations

If, after considering this statement, a registrant and its independent auditors conclude that there is an error in previously-filed financial statements, the registrant would then need to evaluate the materiality of the error.[10] In doing so, registrants should assess the impact of the error on their financial statements to determine whether they are required to file:

l A restatement of previously-issued financial statements; and

l An Item 4.02, Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review, Form 8-K.

The Securities Exchange Act of 1934 requires a registrant to file materially complete and accurate reports with the Commission. Generally, previously-filed Exchange Act reports containing materially misstated financial statements must be amended. The errors in accounting for warrants described above may affect several fiscal quarters and years of a registrant’s previously-filed reports. A registrant may correct material errors related to the accounting issues described above by amending its most recent Form 10-K and any subsequently filed Forms 10-Q, and including in such amended filings:

l restated financial statements and applicable footnote disclosures, including the disclosures required by GAAP in ASC 250, Accounting Changes and Error Corrections;[11]

l restated quarterly financial information in response to Regulation S-K Item 302; and

l revisions to information provided in response to Regulation S-K Item 303, Management’s Discussion and Analysis, based on the restated financial information, explaining the company’s operating results, trends, and liquidity during each period presented and other pertinent information, as necessary.

In addition, registrants should consider their obligation to maintain internal controls over financial reporting and disclosure controls and procedures to determine whether those controls are adequate.[12] Registrants and their advisors should also assess whether prior disclosure on the evaluation of internal controls over financial reporting and disclosure controls and procedures needs to be revised in the amended filings. Such an analysis would necessarily include consideration of whether there is a control deficiency or deficiencies and an evaluation

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of the severity of any control deficiency, individually or in the aggregate. The evaluation of the severity of any control deficiency should not be limited to the actual misstatement that occurred or whether that misstatement was material, but instead should consider the magnitude of the potential misstatement resulting from the deficiency or deficiencies, amongst other considerations.[13] Where applicable, the auditor also will have to evaluate management’s assessment.[14]

This guidance is based on our understanding of the general circumstances surrounding errors related to the accounting for these warrants. Materially different circumstances may warrant different treatment by registrants than set forth above.

To facilitate CF’s processing of pending submissions and filings, a registrant that determines such filings include the accounting error(s) described in this statement and also determines that the accounting error(s) is not material to the required financial statements and disclosures included in the pending submissions and filings may provide the staff with a written representation to that effect in correspondence on Edgar.

In addition, as registrants and their advisors evaluate the effects of any possible changes to their public disclosure, they are reminded of their obligations under Regulation FD not to selectively disclose material nonpublic information.

Conclusion Please direct questions about the evaluation of the technical accounting matters to the Office of the Chief Accountant at (202) 551-5300 or to OCA@sec.gov. Please direct questions about restating financial statements and related guidance to the staff of the Chief Accountant’s Office in the Division of Corporation Finance at (202) 551-3400 or to DCAOLetters@sec.gov.

____________________

[1] This statement represents staff views of the Division of Corporation Finance (“CF”) and the Office of the Chief Accountant

(“OCA”). It is not a rule, regulation, or statement of the Securities and Exchange Commission (“SEC” or the “Commission”). The Commission has neither approved nor disapproved its content. This statement, like all staff statements, has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person. “Our” and “we” are used throughout this statement to refer to CF and OCA staff. References herein to the “Exchange Act” refer to the Securities Exchange Act of 1934.

[2] See Paul Munter, Acting Chief Accountant, Office of the Chief Accountant, U.S. Securities and Exchange Commission, Financial Reporting and Auditing Considerations of Companies Merging with SPACs (Mar. 31, 2021), available at: https://www.sec.gov/news/public-statement/munter-spac-20200331.

[3] See Division of Corporation Finance, Staff Statement on Select Issues Pertaining to Special Purpose Acquisition Companies (Mar. 31, 2021), available at: https://www.sec.gov/news/public-statement/division-cf-spac-2021-03-31.

[4] See Financial Accounting Standards Board Accounting Standards Codification (“ASC”) 815-40.

[5] Entities are required to evaluate this requirement using a two-step approach. First, the entity must evaluate the instrument’s contingent exercise provisions, if any. Second, the entity must evaluate the instrument’s settlement provisions. With respect to the second step of the model, an instrument would be considered indexed to an entity’s own stock if its settlement amount will equal the difference between the fair value of a fixed number of the entity’s equity shares and fixed monetary amount or a fixed amount of a debt instrument issued by the entity. If the instrument’s strike price or the number of shares used to calculate the settlement amount are not fixed, the instrument may still be considered indexed to an entity’s own stock if the only variables that could affect the settlement amount would be inputs to the fair value of a fixed-for-fixed forward

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or option on equity shares. See FASB ASC 815-40-15-7 through 815-40-15-7H.

[6] ASC 815-40-15-7E states: “The fair value inputs of a fixed-for-fixed forward or option on equity shares may include the entity's stock price and additional variables, including all of the following: (a) strike price of the instrument, (b) term of the instrument, (c) expected dividends or other dilutive activities, (d) stock borrow cost, (e) interest rates, (f) stock price volatility, (g) the entity’s credit spread, and (h) the ability to maintain a standard hedge position in the underlying shares.”

[7] See ASC 815-40-25-7 and 815-40-25-8.

[8] See ASC 815-40-55-2 through 815-40-55-6.

[9] More information about how to initiate a dialogue with OCA and what to expect from the consultation process is available on OCA’s “Communicating with OCA” webpage, available at https://www.sec.gov/page/communicating-oca.

[10] See Staff Accounting Bulletin (“SAB”) No. 99 – Materiality, which is codified in SAB Topic 1, Section M – Materiality, available at: https://www.sec.gov/interps/account/sabcodet1.htm#M.

[11] See, e.g., ASC 250-10-50-7 through ASC 250-10-50-10, which sets forth disclosures relating to the correction of an error in previously issued financial statements.

[12] See Section 404(a) of the Sarbanes Oxley Act of 2002, and Exchange Act Rules 13a-15 and 15d-15.

[13] See Commission Guidance Regarding Management’s Report on Internal Control Over Financial Reporting Under Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (Jun 27, 2007), at 35, available at https://www.sec.gov/rules/interp/2007/33-8810.pdf.

[14] See Commission Release No. 34-88365, Accelerated Filer and Large Accelerated Filer Definitions (March 12, 2020) available at https://www.sec.gov/rules/final/2020/34-88365.pdf.

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SURRAN: Special purpose acquisition companies, SPACs, also known as "blank check companies" raise money but are listed on an exchange before they even own any assets. Their goal is to acquire a privately held company within two years.

These are both good enough reasons to be on the SEC's radar. The SEC not only looks closely at filings and disclosures by SPACs in an effort to protect the public interest, but also, in April 2021, issued new guidance on the treatment of SPAC warrants with neither previously issued proposals nor a comment period. An uncharacteristic move that caught financial professionals by surprise.

According to the SEC, all warrants that have been issued recently for SPACs and have already gone through the acquisition process and have companies listed as public, as well as those that are going through that process, need to be recorded as a liability on their balance sheets.

Audit firms, firms assisting management teams and sponsors in forming SPACs and any other firm involved in consulting on SPACs from an accounting and SEC reporting standpoint, have to interpret what the SEC has said. The valuation firms have to value these warrants and come up with a method that's acceptable.

This is a significant accounting change from all the hundreds of companies that have gone public through SPACs, as well as those that were contemplating it. Despite the slowdown of SPAC offerings due to the new regulations, the fundamentals of the SPAC market remain strong, which was evident in The SPAC Conference 2021, that took place in New York in late June.

WILLIAMS: Zac McGinnis, managing director at Riveron Consulting and Josh Schaeffer, director at Equity Methods, join us this month for a more in-depth discussion on SPACs and their execution.

Zac McGinnis' and his firm assist management teams and sponsors in forming SPACs from an accounting and SEC reporting standpoint. They help them through first time audits as well as complex accounting matters. Zac starts our conversation by telling us what he has seen in the first half of 2021 with respect to SPACs.

McGINNIS: The last three or four weeks have been very exciting for those in the accounting and valuation practice around the world, because of the trends leading up through Q1 of '21; we've seen an unprecedented amount of volume; it actually exceeded in the entire 2020 annual period for number of SPACs, but then coming into April, the SEC changed the rules around warrant accounting. That's what we'll talk about a lot today, and it actually has assisted in tapping the brakes with respect to volume.

Our firm had 8 to 10 starts a week in February, March, and early April, and then after the new guidance came out, it really did pause the market quite a bit where folks were going back and restating previously issued financial statements, and then obviously having to roll into the March quarterly filing deadlines in mid-May here.

The new SPAC IPO starts have, from our perspective and for sponsors, caused a little tap of the brakes while folks are reassessing their strategy

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t to go to market around the warrant issue, but also on the de-SPAC side, which we'll talk about here a little bit, and how that impacts the de-SPAC, which is really defined as the business combination when a sponsor finds a target company. It's really back to the timing, the volume, call it the excitement of getting to market a little bit on both sides of the transaction. The warrant accounting issue is probably just one of the reasons why that is, but that will be the topic that we go through today in more detail.

WILLIAMS: Josh Schaeffer, director in the evaluation practice at Equity Methods, helps companies with all matters of valuation of equity and equity derivatives. He also works on SPAC valuations and shares his thoughts from the valuation perspective.

SCHAEFFER: Typically, SPAC transactions have not required a lot of valuations prior to the new SEC guidance due to the accounting classifications. Now, what's happened as a result of the SEC guidance, is we need to help a lot of SPACs navigate the guidance, and also the valuations they need for both the public and private placement warrants in order to update their financials.

WILLIAMS: Zac shares with us some of the biggest challenges sponsors are facing when they form a SPAC.

McGINNIS: Obvious answer here is determining whether or not they want to go to market as a liability classified SPAC, or an equity classified SPAC, which we'll talk about in more detail. Generally, it's around who we are as a sponsor.

What is our business objective? How will we form? Will we go to a Delaware or Cayman based SPAC? What is our business story going to be? Do we want to focus on a particular industry like energy, the most recent craze of ESG, and electric vehicles and the component parts in that industry?

Those are the ones, and I know all of those impact the timing, and if you change your mind on any of those during the S-1 process, or even later, it will cause a little bit of a wrinkle on the timing, maybe some confusion among investors and how you describe those changes to the market and maybe the potential target teams that you're looking at partnering up with.

WILLIAMS: Zac briefly discusses formation and jurisdiction. From a legal standpoint, why Delaware vs Cayman?

McGINNIS: I would say from the accounting and financial reporting standpoint, a Cayman based SPAC typically would need a third party firm to assist them in the formation, which does cause a little bit of an additional cost and work stream or two, versus a Delaware based SPAC in many cases that doesn't require that third party. So, not that big of a deal. Just something to consider if you're choosing one way or the other.

WILLIAMS: From a timeline standpoint, how should companies think about capturing the deal window?

McGINNIS: I'll start with warrants, because that's the exciting topic of the day. So, one thing to think about in hitting the market when the deal window is open is as a liability classified SPAC – are there economic disadvantages either on the target side, on the de-SPAC, or even the sponsor side to go in the market as a liability classified SPAC?

Many of the banks will have a better view of that than myself as a CPA. The MBAs will probably have a better view, but one thing to consider is,

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what are the timing delays going to be? Will I miss my window if I do partner up with a liability classified SPAC versus an equity classified SPAC? Because the market really is familiar and comfortable with equity classified SPACs, and this liability classified warrant issue is new to the market, maybe a little confusing, and what are the real economic consequences of partnering up with a liability classified SPAC? Because many sponsors are wanting to get to market faster, reclassifying it as liability just to get the deal done.

So, what are the economic consequences? Making sure your financial advisors are modeling it on that basis, and do investors care? Because I think there's still a lot of confusion.

The market doesn't really make an economic difference if I'm one way or the other, and the market will show us over time what it really means, because it's still very fresh, right? But the question here in capturing the deal window is, will I experience delays in a de-SPAC, or even in a sponsor IPO standpoint if I go one way or the other? Having the right team around you is obviously something that is going to help you hit that window when it is open, for legal, economic, and accounting.

WILLIAMS: So what are SPAC warrants and how many types are available?

McGINNIS: So, there are really two answers to that question. There's a public warrant and a private warrant.

I'll take the private one first. When a sponsor does an IPO, they raise additional capital on top of the class A shares that they issue. Let's say it's $1.50 a warrant. So, the company raises additional capital that sits in a trust account that's used as part of the purchase consideration for that target company.

That private warrant is an additional 10 million out of the 300 million that's raised in the total SPAC IPO that sits in the liability bucket now, because it has cash settlement features. That's a vehicle in which the company raises just a little bit more capital in the IPO.

The deal terms range, but let's say a private warrant converts into one share in the de-SPAC. It's a way to incentivize additional investors to get into the deal on the front end in that context.

A public warrant is effectively given for free. Let's say I'm a mom and pop investor in SPAC ABC. I invest in class A shares.

I get a free public warrant that may or may not be liability classified, always historically had been equity classified, and now the question is, should it be liability? That Josh can talk about from a fair value standpoint in a bit here, but that public warrant effectively is given let's say for free, that converts into a half, or a third of a share later, and it is, again, an incentive to participate in the de-SPAC later even if I as an investor redeem out in the de-SPAC event.

Let's say I invest in SPAC ABC, and the de-SPAC I'm not happy with the target company that's chosen, and I redeem my initial investment back, I can still participate in the transaction later through that public warrant, if that makes sense. It's a unique incentive for this type of vehicle to access the public markets that's not typically part of the traditional IPO to provide incentive for investors to come into the vehicle.

WILLIAMS: Josh adds a comment about the right investors have to buy additional shares.

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t SCHAEFFER: With these SPACs, we see in addition to the common shares that people are buying, they get the additional right to buy more shares. Almost always, this right, which is called a warrant, allows for the purchase of additional shares at $11.50, where the offering price is $10. What that means is if the company goes up in value, that allows these investors to buy more and more shares at a fixed price.

SURRAN: A SPAC raises money for a stated goal. That money is kept in a trust for up to two years, the time frame the SPAC has to find and acquire a privately held company. There are no guarantees that a SPAC will go public or find a company to acquire and take public but that money is pledged for two years.

Once a target company is identified and the acquisition process starts through a letter of intent, the due diligence phase begins. That includes accounting and tax review of the company, legal review and valuation.

The de-SPAC transition process begins when the merger is formally announced, which is at the time the due diligence phase is complete, is close to completion or even in parallel.

An S-4 proxy financial statement with audited numbers and a prospectus need to be filed with the SEC once the merger agreement is signed, investors are notified and the merger is publicly announced.

WILLIAMS: The de-SPAC transition process can be quick or take as long as 30 days for the SEC to review the filings and release their comments. The de-SPAC approval process requires accuracy and is also tedious as it is very detailed. Zac McGinnis gives us further details on the de-SPAC transactions and transition process.

McGINNIS: A de-SPAC transaction, it's a short term for the ultimate business combination. So, when a SPAC sponsor raises, let's say, 300 million dollars in month one, then they have 24 months to legally acquire a private company in order for that private company to then be the public SEC registrant within the 24-month period.

The de-SPAC transaction is the actual legal business combination that happens, let's say, in month 15 prior to the 24-month SPAC clock expiring where the sponsor legally acquires the target company with additional pipe capital to get to 800 million, for example, for purchase consideration.

They legally acquire that private target company for 800 million, and then through a series of SEC reviews on form S-4 and a Super 8-K later, that private company then becomes the SEC registrant from that point going forward.

So, it's a way in which a private company can go public without having to do a traditional IPO. It's become very popular recently for a few reasons. Well, a SPAC warrant is issued at the SPAC IPO in that month one. Then for the de-SPAC, there's a series of conversions in which the warrant holders either continue to be warrant holders, or those warrant holders are now equity holders in that newly formed, or newly merged entity. In month 15 in my example, the private company becomes the SEC registrant, and then they have to file Qs and Ks thereafter. That's a de-SPAC. Legally, the legal term of de-SPAC really doesn't exist. It's just a way to label that instead of having to say business combination or any other legal terms, reverse merger, and those types of terms. It's interchangeable with a few other glossary terms, if you will.

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t WILLIAMS: Josh Schaeffer continues by discussing the value of the warrants.

SCHAEFFER: Because of the nature of the SPAC as an entity, the value typically doesn't change much until a de-SPAC transaction is committed to What that means is that the warrants themselves don't have a lot of value until the de-SPAC occurs, and certainly, you wouldn't expect them to be exercised if that's even available. Now, the warrants also have a feature that their life is actually based on the timing of the de-SPAC, because typically they will survive for five years after this merger transaction. So, if the SPAC finds a target and merges within three months, that would be a shorter lived warrant overall than if it did it in 21 months, three months before the SPAC period ended.

WILLIAMS: In April 2021, the SEC issued a statement on the accounting treatment of SPAC warrants. Zac shares his insights as to the current treatment and what led to it.

McGINNIS: The history here is probably 800,000 SPACs that for 78 years have classified these warrants as equity since the beginning of time, so to speak, and the terms and conditions of the warrant agreement generally, I'm sure there are exceptions out there but generally, were the same. Each sponsor used the industry and regulatory accepted legal terms and accounting policies in their S-1 and even through the de-SPAC for many, many years.

Since these types of transactions have become more and more popular, the SEC is starting to look at their accounting policy and whether based on the terms of the warrant agreement they are consistent with generally accepted accounting principles. After continued review, the SEC began to challenge it, and then as you mentioned in April of '21, seems like three years ago, but it was really about five weeks ago, that the SEC issued interpretive guidance and their views on the historically accepted accounting policies of equity classification.

A couple of reasons why they chose that was around the settlement provisions of these warrants being of a cash nature. The unlikely one percent likelihood just to be extreme that a private warrant would be settled with cash, under generally accepted accounting principles that could be viewed and is viewed by them now as liability classified.

So, again, it's a very technical accounting change that the banking community, not to speak for them, seems not to be too fussed about the economic consequences of it, but rather it's a GAAP issue that could be excluded or explained in certain models, but again, as an accountant, I don't want to be too definitive. The reason the accounting policies changed was in a general sense the cash settlement provisions of these warrants. So, any time an instrument can be settled in cash in GAAP, the beginning point is, and now is even more strongly so let's start a liability and then prove to ourselves that it's equity, versus let's start with equity and prove to ourselves that it's liability. I think that's where a lot of folks are.

Then also the accounting and presentation of deferred offering cost has also recently been re-looked at, not by the SEC, but by some of the audit firms to allocate a portion of those deferred offering costs to that warrant liability. The accounting follows the warrant accounting each quarter thereafter. If there's fair value through the income statement, and there's a charge that goes through the income statement, then some of those deferred offering costs will follow that treatment in general.

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t SCHAEFFER: One factor that comes into play here, especially with the cash settlement provision, is the probability that certain of these events might be seen as remote, or perhaps even less than remote.

The way the treatment worked under the current guidance is that even if it has almost no, or effectively literally no chance of occurring, that still can change the accounting consideration. That was touched on in the working group for the SEC, and did not come out in new guidance that perhaps remote events should not change the classification of events, similar to what they did with down round provisions a couple of years ago.

WILLIAMS: So when do SPACs or the combined company following a de-SPAC transaction have to restate?

McGINNIS: The accounting and the SEC reporting guidance of SAB 99. When a company has previously issued financial statements with a material misstatement, they're required to go through an assessment of whether or not, and again, this is industry verbiage here, but is it a big R, or a little R, or really no R.

Someone who grew up in an audit practice for many, many years, SAB 99 issues are relatively common to determine, are your historical financial statements materially misstated?

Big R is where we have to go back and refile the last two years of annual financial statements if it's big R so that the investors aren't making investing decisions today on materially incorrect published financial statements.

The rules of thumb, there are certain quantitative rules of thumb that we don't have to get into here, but let's say it's 25% of pre-tax income for the last year. That generally would be expected to be a big R, and then you would need to go back and refile your annual financial statements since it's so big.

There's also balance sheet and non-debt metrics quantitative metrics as well to consider. Anyway, the company needs to go through the assessment, write a memo.

The others would need to consult their national office to all agree that it's big enough to go back and refile your audited financial statements from prior periods. If, let's say, it is a mistake, but it's not so big – the investors are still making wise decisions on our previously issued financial statements – then what a company would need to do, like a SPAC for example, they can file their next Q, let's say for example March or June with the historical financial information revised.

So, you don't have to go back and refile your annual financial statements in a K or an S-1, but you can change it in your next filing. That's the general rules on little R. Facts and circumstances regulated here. If it's so small, we should have put this sentence in a footnote. It's not big R, not little R. Again, we're going to change it as we go in the future.

What's interesting in the SPAC world is if you're a SPAC, you're a publicly traded SPAC, and you're just waiting to de-SPAC, it's very simple to go back and say I'm going to revise, let's say it's big R. I'm going to revise my 10K for 12/31/20. I'm going to in my 3/31/21 Q obviously going to reflect that change as well. That's relatively manageable.

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t What's difficult is if I'm going to de-SPAC and I'm filing my first S-4 registration statement on May 10th, and now on April 28th, I have to go back and change the de-SPAC at the restate, that obviously impacts the S-4 filing quite significantly.

In the third bucket are folks that have de-SPAC'd in 2020 or 2019 or 2018. Those clients had to go back and assess whether they had a restatement for many, many years. I would say that third bucket was the challenging bucket, because it impacts so many prior periods. It impacted obviously the de-SPAC, and then every K and Q that was issued thereafter.

Our clients that had large balance sheets, so to speak, could absorb that mistake and not call that a big R and they could change it in their future, let's say, their March Q that was filed recently. So, the small companies obviously couldn't absorb it because the mistake or the error or the previously issued error was so large that there had to be revisions and refiling of previously issued financial statements.

SURRAN: Josh Schaeffer discusses some of the key factors we need to consider with respect to the initial SPAC price, public call provisions, and additional features with respect to SPAC warrants. He also gives us his insights on volatility.

With respect to volatility, there are two periods. The first one is when a SPAC is looking for a target company to acquire and take public and the second period is after the acquisition, when the company is no longer a target, but is a publicly traded company, an operating company. And that's one more factor to consider when we are talking about SPAC warrants.

SCHAEFFER: When we're looking at these warrants, we really need to consider what the key terms are. So, at their core, they operate like plain vanilla warrants or options that you might see in the market. What you're seeing there is the key terms of things like the stock price, the strike price, the term, the volatility, and then for those who remember Black Scholes, the other two inputs are the risk free rate and dividend yield. Of course, SPACs are not paying dividends, so we don't need to worry about that. When we go to the SPAC warrants, there are a few additional features we need to consider.

The first of those is that the term here is variable. It typically goes until five years after you have a de-SPAC transaction. So, as we discussed earlier, that can be very short, or longer with a two year window of when the de-SPAC occurred.

Another factor that's on a lot of these warrants is that there is the right for the company to call the warrants and force early exercise if the stock price goes up, and almost always that's worded as if the stock price goes above $18 for 20 out of 30 days, the company has the right to offer a penny to buy back the warrants unless the holder exercises. Any logical holder upon seeing $6.50 in intrinsic value or a penny is going to pick the $6.50. That can effectively cut the life shorter.

Another factor that we have to consider is we don't even know what kind of company we're looking at here. When we're looking at the volatility, we have one period where this company is a SPAC and doing whatever it will do looking for a target, but then we have another period where this

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t company is a publicly traded company that is an operating company. So, all of those factors have to go in when we're thinking about these warrants.

Now, one other factor that's in more recent SPACs, in addition to the public warrants being callable, the private warrants might also be subject to a call. What typically happens with the private warrants is there are limitations on the call as long as they're held by the initial issuer, or their affiliates. What happens in these situations is that there may or may not be the ability for the company to call those warrants along with the public warrants.

WILLIAMS: So what is the probability of failure?

SCHAEFFER: We know that historically, approximately 10% of SPACs have not found a target and have returned the capital to investors. We're certainly not sure with the current environment how that number will change, because you do have more SPACs out there, and more competition. Now, if I have a warrant that has some probability of having the ability to buy something, and some probability that it expires worthless, I would certainly pay less for that than a warrant in a company that I understood would survive ‘til the end of the period, or at least believe there is an extremely high probability because I know what I'm holding.

WILLIAMS: And how about modeling? Looking at Black Scholes versus Lattice versus Monte Carlo simulation models, is one better than the other? How are they different and how would they behave if the volatility changes mid-stream?

SCHAEFFER: Black Scholes are the typical model that we would use for valuing warrants or some version of it. It's not the most advanced model for valuation out there, but especially for financial reporting, it gets us results that are consistent with the terms of most market traded warrants and options.

However, here we have the special factors such as a call provision that don't fit into the Black Scholes model. So, we do have a few other kinds of models that we can use that look somewhat similar to Black Scholes, although in different key ways.

For example, we can calibrate what's called the lattice model, which gives a tree of stock prices, and say that if the stock price gets above X, say for example $18, the holder will call right away rather than waiting for the end of the period. This is a model we use a lot in employee stock options, where we see that employees do tend to exercise their options early, so very similar to that.

Now, another model that we can use is Monte Carlo simulation. Monte Carlo simulation is basically just breaking down the formulas in Black Scholes or lattice models into random trials. So, instead of having distributions that are well specified, we're going to pick a number that we think the future stock prices or path that the stock price is going to follow, see what investors do, and repeat that typically around a hundred thousand times to see what the value is as a result. By doing that, we can, for example, do a daily simulation, and actually calibrate for the 20 out of 30 day rule.

We can change volatility mid-stream. We can put in a probability of failure directly into the model. These various factors going in can allow us to get to a more useful value, taking into account all of the key features, and also allow us to distinguish between the conditions for the public warrants and the private warrants.

WILLIAMS: Josh gives us his insights with respect to timing regarding the two periods during which we value warrants.

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t SCHAEFFER: We have two periods at which we're typically valuing these warrants.

The first period is at issuance, and at that point, people are buying a share of stock plus a fraction of a warrant, maybe a quarter to a half, and they're paying $10. So, from a valuation perspective, we need to understand that the overall value of that portfolio, what they're buying has to be equal to $10.

What that means is we need to tinker around with the stock price because the higher the stock price, the higher the warrant value, which of course increases the unit value. So, we need to play around until we get to a value result where investors actually pay $10.

Later on in the situation, the public warrants will begin trading, and typically that's around two months after the IPO of SPAC. When we have that, we can look at those public warrants and see what kind of volatility is actually being estimated for those based on the pricing model that we might use.

Once we have that, we can adjust the model for the public and private warrants based on the differences in their terms. That's something that we definitely want to do further down the road. Now, early on, we don't have a lot of indications of volatility. We do know what other recent SPACs have traded at. Typically, those might indicate a volatility that we see as lower than we typically see for small companies in options and warrants, but using the prior issue as an indication gives us a good ability to look and think about how much these things should be worth at their issuance when we don't have any better information.

WILLIAMS: Zac McGinnis and Josh Schaeffer conclude our segment on the accounting and valuation of SPACs and leave us with their final thoughts.

McGINNIS: This quarterly reporting period requirement to update the liability classified warrants adds just a layer of something else on the project plan sponsors and companies are going to have to deal with, if they do choose liability. Every reporting period thereafter would need to refresh the valuation.

The industry will get more and more sophisticated and efficient as we go now that the novel has been written, so to speak. We can update that novel every quarter, but it just adds on a layer of work stream on the project plan that will have to be assessed.

For those sponsors that are contemplating forming and IPOing a SPAC, call those pre-IPO SPACs, versus the folks who have to deal with the issue in the historical period with the restatements that we talked about before. I think that those sponsors have the time, if their investors allow them to have the time, and their founders to get it right, to really look at the legal terms, work with their auditors and accounting advisors and bankers to say we accept these terms if we want to go with equity treatment like the historical presentation, they have that time, and that's what's probably exciting. Even serial SPAC sponsors that are doing SPAC number 12, or 15, or 26, they're going to be in that same bucket. So, it will be interesting to see what those legal terms will look like and what the SEC will accept, and if they do want to take the time, they do have that time. For those sponsors that want to go fast, liability classification is something that seems to be accepted, let's get to market,

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t and we'll deal with any economic disadvantages of being a liability classified SPAC later.

SCHAEFFER: There are a few key terms in the warrant agreements that both drive out the classification, but also the value. So, it's worth taking a quick look at your agreement. Perhaps for somebody who focused on valuations to do a look and develop an understanding of what this might mean from a value perspective, and to do that ahead of time. It doesn't take long at all. There are a few spots in the agreement, and we all by now given the volume we've processed know exactly where to look. So, something like that can be a great first step for companies just working on their legal agreements. For companies who were already done, what's done is done.

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Segment Three

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3. Related Party Transactions – A Recurring Issue

Learning Objectives:

Segment Overview:

Field of Study:

Recommended Accreditation:

Running Time:

Video Transcript:

Course Level:

Course Prerequisites:

Advance Preparation:

Expiration Date:

Accounting

November 6, 2022

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

None

1 hour group live 2 hours self-study online

Update

See page 3–22.

33 minutes

Related party transactions seem to be a recurring issue, and the reason is primarily two-fold. One, there's been a significant amount of related party frauds that were discovered only after the fact. And two, there's been criticism of related party disclosures in that they don't provide an accurate view of the related party activity that took place within the reporting entity. Identifying related party relationships and related transactions is not as straightforward as one might think. John Fleming, CPA, discussion leader at Kaplan Financial Education, focuses on the importance of such transactions and their impact on the fair representation of financial statements.

Upon successful completion of this segment, you should be able t l Understand the related party guidance available based on the

type of your entity, l Recognize the definition of related party and related party

transactions, l Determine the related party disclosure requirements based

on the accounting guidance followed, and l Identify the differences between management and auditors’

responsibilities with respect to related party transactions.

Reading (Optional for Group Study):

“Related party Transactions – A Recurring Issue’ See page 3–12.

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A. Recurring Related Party Transactions

i. Discovered after the fact

ii. Inaccurate disclosures

B. Available Guidance

i. FASB Topic 850

ii. IASB IAS 24

iii. SEC S-K item 404

iv. PCAOB AS 2410

v. ASB & IAASB Section 550

vi. AICPA Practice aid

C. Related Parties

i. Affiliates

ii. Equity method investments

iii. 20% to 50% company ownership l Control or significant influence

b Through agreements or contracts

I. Defining Related Parties & Transactions

A. Disclosures Under FASB Topic 850

i. Nature of relationship

ii. Description of transactions

iii. Dollar amount of transactions l For each period presented

iv. Changes in terms within periods

v. Receivable or payable balances

vi. Settlement terms

vii. Nature of control relationship, if any

B. Is Related Party Disclosure Required?

i. A company’s choice to disclose l Maintain the relationship in

private

ii. FASB provides disclosure requirements

C. Related Party Transactions in Other Notes

i. Equity method

ii. Investment

iii. Guarantees

iv. Equity

v. Business combination or consolidation

vi. Franchise

vii. Other control relationships

II. Disclosures Under FASB

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A. Related Parties Under IAS 24

i. Persons or entities related to the reporting entity

ii. People and/or family members l Control or significant influence l Ownership l Management

iii. Entity that’s a member of a group l Joint venture l Post-employment benefit plan

for reporting entity’s employees

B. Related Party Disclosures Under IAS 24

i. Nature of parent/subsidiary relationship l May be under consolidation note

ii. Key management compensation

iii. Description of transaction

iv. Uncollectible receivables

v. Expense recognized

C. Separate Disclosures In

i. Parents

ii. Entities with joint control or influence

iii. Key management personnel

III. IAS Definitions & Disclosures

A. Item 404 – Four Disclosure Areas

i. General disclosure requirements

ii. Policies and procedures for review, approval and ratification

iii. Promoters and certain control persons

iv. Corporate governance

B. Terms Identified Under Item 404

i. Transaction

ii. Registrant

iii. Related person

iv. Disclosure requirements l Person’s name & relationship l Person’s interest l Dollar value of the transaction l Any other material information

IV. SEC Interpretations & Disclosures

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A. Management’s vs Auditors’ Responsibilities

i. Management could elect l Not to disclose l Not to identify related party

activity l Not to identify related party

transactions b Financial statements would

be misrepresented

ii. Auditors need to l Ensure proper accounting and

disclosure l Identify related party

transactions

B. Auditors’ Objectives

i. Understanding of related party transactions

l Different from seeking out & identifying undisclosed related parties

ii. Obtaining sufficient appropriate audit evidence

C. Minimizing Risk of Material Misstatement

i. Inquiries into authorization of related party transactions

ii. Reasons for any exceptions granted

iii. Ensure proper accounting and disclosure

“The more information we have about related parties, the more likely that we can ensure that they've been accounted for and properly disclosed.”

— John Fleming

V. Auditor & Management Roles

A. Auditors Should Evaluate

i. Proper identification and reporting

ii. Accuracy and completeness

B. Testing for Accuracy & Completeness

i. Is the list correct?

ii. Is it complete?

iii. Perform additional procedures

iv. Evaluate balances with affiliated entities

v. Look for authorizations consistent with policies & procedures

vi. Proper accounting and disclosure

C. Evidence, Skepticism & Fraud

i. Confirm business purpose

ii. Consider the likelihood of influence

iii. Evaluate the information obtained

iv. Consideration of fraud & misstatement

D. Special Purpose Entities

i. Structured to misrepresent financial reporting

VI.Evaluation & Testing

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3. Related Party Transactions – A Recurring Issue

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

“In this segment, John Fleming focuses on the importance of related party transactions and their impact on the fair representation of financial statements.”

l Show Segment 3. The transcript of this video starts on page 3–22 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 3–7 to 3–9. Additional objective questions are on pages 3–10 and 3–11.

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

1. What related party guidance is available? What related party guidance pertains to your organization?

2. What is the FASB 850 definition of a related party and what disclosures are required by FASB Topic 850? How does your organization typically present related party disclosures?

3. How does IAS 24 define related parties and what disclosures are required under that guidance?

4. What are the four disclosure areas and terms identified under Regulation S-K Item 404?

5. What are the differences between management and auditors’ responsibilities with respect to related party transactions? How do management or auditors’ responsibilities impact your organization?

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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s6. What is the link between performing

audit procedures to respond to the risk of material misstatement and the risk identified in the area of related parties? What are some ways to test for accuracy and completeness? How has your organization responded to the risk of material misstatement regarding related parties?

7. What is the evaluation process of evidence obtained and testing considerations? What are some related party testing considerations that apply to your organization?

Discussion Questions (continued)

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1. What related party guidance is available? What related party guidance pertains to your organization? l FASB – Topic 850, Related Party

Disclosures l IASB – IAS 24, Related Party

Disclosures l SEC – Regulation S-K item 404,

Certain Relationships and Related Transactions••

l PCAOB – AS 2410, Related Parties l ASB – Section 550, Related Parties l IAASB – Section 550, Related Parties l AICPA – Practice Aid, Accounting

and Auditing for Related Parties and Related Party Transactions

l Participant response based on personal/organizational experience

2. What is the FASB 850 definition of a related party and what disclosures are required by FASB Topic 850? How does your organization typically present related party disclosures? l Related parties include:

b Trust for the benefit of employees b Principal owners of the entity b b Members that are immediate

family v Mother/father v Brother/sister v Son/daughter v Management of the entity and

members of their immediate family

b Affiliates identified as related parties

b Equity method investments b Exists when you have between

20% – 50% ownership in a company

b Any party that has significant influence or control over management or operating policies to the extent that one party might be prevented from fully pursuing its own separate interest

l Control can happen through agreement or contract

l FASB Topic 850 disclosures b Nature of the relationship b Description of the transactions b Dollar amount of the transactions

v For each period presented b Changes in terms of transactions

from year to year, if the changes take place

b The receivable or payable balances at the balance sheet date v On the face of the balance sheet

or in a note disclosure b Settlement terms of receivables or

payables, if not obvious b The nature of any control

relationships, if that should exist l Participant response based on

personal/organizational experience

3. How does IAS 24 define related parties and what disclosures are required under that guidance? l Persons or entities that are related to

the reporting entity b Related party people or related

party entities that participate in some type of transaction where one or more tends to benefit from that related party transaction

l Person or close member to that person’s family: b Who controls or has significant

influence over the reporting entity b Who has ownership b In management

3. Related Party Transactions – A Recurring Issue

Suggested Answers to Discussion Questions

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sl A member of the same group in which

the reporting entity is also a member b An associate or joint venture of the

reporting entity b A post-employment benefit plan

for the benefit of employees or the reporting entity or the entity related to the reporting entity

l Disclosures b Nature of any parent/subsidiary

relationship, even if there has been no related party transaction

b Key management compensation b Description of any related party

transactions such as purchases, sales, leases, guarantees

b Amount of any related party transaction during the reporting period

b Provisions of any uncollectible receivables related to the amount of outstanding balances

b Expense recognized during the period for debt or doubtful debts due from related parties

4. What are the four disclosure areas and terms identified under Regulation S-K Item 404? l General disclosure requirements for

related person transactions b Including those involving debt

l Disclosure regarding the company’s policies and procedures for the review, approval, and ratification of the related party transactions

l Disclosures regarding promoters and certain control persons of the company

l Corporate governance disclosure requirements and the independence of directors

l Terms identified l Transaction

b Registrant – a participant with any related person having a direct or indirect interest in the registered party

b Related person – any person who is an executive officer or their immediate family or a security holder

b Disclosure requirements v Person’s name and relationship

to the company v The person’s interest in the

transaction with the company v The approximate dollar value of

the amount involved in the transaction

v Any other information regarding the transaction of the related person in the context of the transaction that is material to investors

5. What are the differences between management and auditors’ responsibilities with respect to related party transactions? How do management or auditors’ responsibilities impact your organization? l Management could elect:

b Not to make related party disclosures

b Not to identify related party activity

b Not to identify related party transactions

l Even though management may have reasons for not wanting to disclose related party activity, the financial statements would be misrepresented with respect to those transactions

l Auditors have the responsibility to: b Ensure whatever related party

activity has taken place has been properly accounted for and properly disclosed

b Identify related party transactions either by: v Having the client disclose the

transactions OR v Identifying a situation through

other auditing work and following up with those findings

l Participant response based on personal/organizational experience

Suggested Answers to Discussion Questions (continued)

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s6. What is the link between performing

audit procedures to respond to the risk of material misstatement and the risk identified in the area of related parties? What are some ways to test for accuracy and completeness? How has your organization responded to the risk of material misstatement regarding related parties? l The auditor should evaluate:

b Whether the reporting entity properly identified its related party relationships and transactions v The auditor inquires and gets a

list of related parties or related party transactions

b Whether the auditor included procedures to test the accuracy and completeness v The guidance states that the list

has to be tested for accuracy and completeness

b Testing for accuracy and completeness v Is the list correct? (accuracy) v Does the list have everything

on it that should be on it? (completeness)

v Additional procedures in the related party area that may not have been done in the past

v Evaluate if procedures were performed on balances with affiliated entities k Has the underlying

document been read to determine the terms and information are consistent with explanation and other audit evidence?

k Has authorization been consistent with policies and procedures?

k Has the transaction been accounted for properly?

k Has adequate disclosure been made?

l Participant response based on personal/organizational experience

7. What is the evaluation process of evidence obtained and testing considerations? What are some related party testing considerations that apply to your organization? l Confirm the business purpose

b Consider the likelihood that the reporting entity could influence a related party

b Evaluate information obtained about the financial capability of the parties to a transaction

b Consider fraud related to the risk of misstatements

b Management override is often associated with related party activity by: v Creating fictitious terms of

transaction with related parties designed to misrepresent the business purpose

v Fraudulently organizing the transfer of assets from or to management or others at an amount significantly above or below market value

v Engaging in complex transactions with related parties

l Participant response based on personal/organizational experience

Suggested Answers to Discussion Questions (continued)

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1. AS 2410, Related Parties, is issued by the:

a) FASB

b) IASB

c) PCAOB

d) SEC

2. Related parties include:

a) equity method investments

b) 2% owned public companies

c) competitors

d) a friend of management of the company

3. Which of the following is one of the basic related party disclosures required by FASB Topic 850?

a) guarantees

b) nature of the relationship

c) business combinations

d) limited liability or LLC entities

4. The auditor's responsibility regarding related party activity is to:

a) design and implement a system for the client to properly track related party transactions

b) decide whether or not to disclose related party relationships and transactions

c) ensure that whatever related party activity has taken place has been accounted for and disclosed properly

d) provide a list of possible related parties to the client and have management agree with that list

5. After obtaining a list of related party transactions, the auditor should test for:

a) existence and occurrence

b) valuation

c) allocation and classification

d) accuracy and completeness

6. When testing for accuracy of a list of related party transactions, the auditor should:

a) determine if the list is correct

b) NOT have to perform any additional procedures

c) refrain from exercising professional skepticism

d) recognize that the reporting entity does NOT have to disclose related party transactions if it chooses not to

7. FASB Topic 850 disclosures:

a) are NOT required if management must hide related party transactions from outsiders

b) should include the dollar amount of the related party transactions

c) requires receivable balances to be on the face of the balance sheet

d) requires the names of the related parties

8. Which of the following disclosures is required by IAS 24, but NOT by FASB?

a) nature of a parent/subsidiary relationship

b) amount of any related party transaction

c) description of related party transactions

d) key management compensation

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 3–12.

Objective Questions

3. Related Party Transactions – A Recurring Issue

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9. With regard to related parties, an auditor must:

a) seek out undisclosed related parties

b) identify undisclosed related parties

c) gather audit evidence about related party activity

d) confirm all balances

10. A trigger that suggests there may have been a related party transaction is:

a) extending payment terms not offered to others

b) lending money with interest

c) allowing returns

d) buying goods at fair market value

Objective Questions (continued)

3–123–123–123–123–12

Self-Study Option

Reading (Optional for Group Study)

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RELATED PARTY TRANSACTIONS – A RECURRING ISSUE

By: John Fleming, CPA Discussion Leader Kaplan Financial Education

Both the accounting standard setters and the audit standard setters, the regulatory standard setters, if you will, have enhanced their related party guidance in the area of performing risk assessment procedures to identify related parties and related party transactions, as well as enhancing audit procedures to hopefully permit the auditor to identify related party activity in a more meaningful manner. So those are the recurring issues and both the accounting and auditing folks have been looking more closely at these issues during the past few years. So the learning objectives for this program include, identify the importance of related party relationships and transactions to the fair presentation of financial statements. Identify and illustrate accounting guidance associated with related party transactions and disclosures, and identify and illustrate auditing guidance associated with auditing related party transactions. So that's the primary focus of this program.

So when we think of related parties, we have related parties as individuals or as entities that are not necessarily involved in arms length transactions with the reporting entity. There may be related party transactions. If so, there's requirement for related party disclosures and in addition to that, there is audit literature related to identifying the reasonableness overlay to party activity, the purposes of it, has it been accounted for properly, et cetera. And a lot of that auditing guidance triggers down to review and compilation guidance also. While we don't have review and compilation guidance in this program, a lot of the guidance that comes out of the auditing literature is similar, certainly in the review literature and is certainly implicit in the compilation literature.

Let's take a look at a number of related party frauds. I think it may make sense to look at what some entities have actually done. The Baptist Foundation of Arizona was a arm of the Baptist Church. And they had outsourced the management of their contributions. They outsourced the investing of those contributions, and the management group fraudulently established a number of fraudulent not-for-

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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profit organizations, then made distributions to those not-for-profit organizations. And those distributions ended up in the hands of the management of the foundation. So they use fraudulent related parties to deposit funds that in turn were given to the managers of the folks who were running the foundation, using in effect a related party, a fraudulent not-for-profit. Adelphia Communications, the CEO's wife had a office supply company and Adelphia mandated that all supplies had to be purchased from her company.

And she grossly overstated the pricing of supplies that Adelphia was paying the CEO's wife or let's say the CEO's family, substantial dollars for products that could have been purchased elsewhere at far less. Rite Aid, a couple of the directors own property. They sold the property to Rite Aid at inflated prices as locations for Rite Aid to build a store. Boston Scientific overpriced product that was selling to related party customers and then there was a sharing of that overpricing with folks at Boston Scientific and the related party customers.

AIG pay a fraudulent claims to related parties. And then there was again a sharing of this fraudulent claims. Lernout & Hauspie, established false vendors, I'm sorry, false customers throughout Asia. And they were allegedly selling technology to those customers and recording revenue based upon those sales, when the reality is those companies did not exist. Parmalat borrowed billions of dollars from a related party bank, never recorded the borrowings as borrowings. They were recorded as sales and the paybacks were not recognized on the books of Parmalat.

So we have a number of related party frauds, none of which were discovered when the activity took place. All were discovered after the fact through some other means, whether it be a whistleblower or whether it be an employee or whether it be an investigation that may have taken place by say the SEC. And all of these obviously resulted in significant financial misstatements, all using related parties as the means of creating the fraudulent misstatements of the financial statements.

So the related party literature consists of a number of different, or comes from a number of different groups. FASB has guidance in topic 850, related party disclosures. We'll look at that first. The IASB has IAS 24 related party disclosures. The SEC regulation S-K is item 404, certain relationships and related transactions. PCAOB is AS 2410, on related parties. The Auditing Standards Board and the international auditing folks have section 550 on related parties. It's a little bit different, but the same numbering. And AICPA has established a practice aid called accounting and auditing for related parties and related party transactions. And that I have at the end of the program, just to illustrate it for you.

So let's look at some of the accounting issues first. So we have FASB topic 850 in related party disclosures, ISB-IAS-24 on related party disclosures. And the SEC item 404, certain relationships in related transactions. So the first one topic 850. Topic 850 defines a related party as a business or personal arrangement between two parties. They could be entities, they could be individuals, who have a prior or existing relationship that can result in preferential benefits for one or both parties.

And I might add that it normally benefits both parties somehow. That's usually what happens here, both parties benefit. Years ago, there was a case with a company called Enron, where they established false companies, fraudulent companies that existed in name only. These companies borrowed money from banks and guaranteed the borrowing. So the banks provided the money to these in effect paper companies.

Then the paper company took the borrowings and transferred it to Enron and Enron recognized the borrowings as sales, overstating revenue by billions and billions of dollars. So who benefited from all this? To people that were involved in establishing these off-balance-sheet entities that existed in name only, they were the people who benefited because they were getting bonuses based upon revenue growth.

So by using this off balance sheet related party, they were able to overstate revenue in Enron's books and as a result, cash out with

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performance bonuses that they allegedly earned. So again, benefits for one or both parties. That related party definition includes affiliates being identified as related parties, equity method investments, and remember that they exist when you have between 20% and 50% ownership in a company. So you have significant influence, in other words, trust for the benefit of employees, principal owners of the entity and members that are immediate families, that's mother, father, brother, sister, son, daughter, management of the entity and members of their immediate families, and any party that controls or can significantly influence the management or operating policies to the extent that one party might be prevented from fully pursuing its own separate interest.

We see control happening sometimes through an agreement or through a contract, where a reporting entity is interested in obtaining something that can help it be better at what it does, but they can't get that or do that without permission from another entity. So the other entity to protect its interest may require that for a period of time, they have control or influence over the operating activities of the reporting entity. And if that's the case, that would clearly be a definition of related party.

So the disclosures required by topic 850, by FASB, include the following, the nature of the relationships, description of the transactions, dollar amount of the transactions during each period presented, changes in the terms of transactions from year to year, if those changes take place, the receivable or payable balances at the balance sheet date, and they should either be on the face of the balance sheet or in a note disclosure. Settlement terms or receivables or payables, if not obvious, and the nature of any control relationships, if that should exist.

Now, this note disclosure... Well, it has seven points to it. Oftentimes the company makes this note disclosure in a paragraph or two. It's often not a lengthy note. So the nature of relationship between company A and B, description was a purchase or sale

or guarantee, the dollar amount was for $1 million. Maybe there was no change in terms, the balances reported on the balance sheet, the settlement terms were identified, and there may or may not be control relationships. The point being that this is not usually a lengthy note. And if it happens to be a related party fraudulent transaction, then this note is not even written, it's not even presented.

So when a company participates in a related party fraud, they don't disclose it. They don't highlight it in their financial information. So the first issue is in terms of recurring issues, related party frauds that are not discovered till after the fact, the second issue is the adequacy of related party disclosures. And topic 850 has everything covered as long as we're not talking about a fraudulent transaction.

In some instances, even if it's not fraud, the company chooses not to disclose related parties and they choose not to disclose them because they don't want others to know about the related party activity that's in place. So while FASB says, this is what you should disclose, it doesn't necessarily mean that's what gets disclosed if a company must hide related party transactions from outsiders.

Other related party disclosure areas may show up in the equity method, investment note, in a guarantee note, in an equity note, in a business combination note, in a consolidation note, or a franchise note, limited liability, LLC, LOP entities, or where there may be some control relationships that have to be disclosed. So we've got the basic related party disclosure in topic 850, and then there may be additional commentary on related parties in other notes, due to the nature of some activity that may be taking place in that type of transaction. IAS 24, it's related party definition is not terribly different from FASB's related party definition.

It is persons or entities that are related to the entity, the reporting entity, that is preparing its financial statements. So we're looking at just as FASB does, related party people or related party entities that

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participate in some type of transaction where one or more tends to benefit from that related party transaction. So the IAS 24 goes on to expand this definition, just like FASB expanded this definition, to indicate that a person or close member to that person's family, who controls or generally controls or has significant influence over the reporting entity, that's the related party. That person or close family member is a related party.

A person or a close member of the person's family who was part of key management personnel of the reporting entity or the reporting entity is spared. So the first bullet is really ownership and close family members of the ownership. The second is management and close family members of management. Third bullet, an entity that is a member of the same group in which the reporting entity is also a member and a GAAP refers to that as an affiliated organization.

An entity that is an associate or joint venture of the reporting entity or vice versa. IAS 24 goes on to say, as part of its related party definition, an entity that is a member of a joint venture, which the reporting entity is a venture of. An entity that is a joint venture with a third party, obviously reporting entity is an associate of that third party. An entity that has a post employment benefit plan for the benefit of employees or the reporting entity or the entity related to the reporting entity.

So in US GAAP, that would be a pension or post-employment plan. Internationally it's a post-employment plan. And the related party disclosures in IAS 24 include the following, the nature of any parent subsidiary relationship, even as there has been no related party transaction. Now that note in FASB might be in the consolidation note more than the related party note. Key management compensation. This is something not required by FASB. To some degree is required by the SEC, but the IAS requires management compensation being included in its related party note. And for this reason related party notes

internationally are normally a bit longer than related party notes required by FASB.

The description of any related party transactions such as purchases, sales, leases, guarantees, again, same as FASB. The amount of any related party transaction during the reporting period same as FASB, provisions of any uncollectible receivables related to the amount of outstanding balances. In FASB we would normally see that in the receivable note. The expense recognized during the period for bed or doubtful debts due from related parties. Again, you would normally see that in the receivable note in FASB.

Then separate disclosures will be made for each of the following, there would be disclosures in the parents, entities with joint control or influence, subsidiaries, associates, joint ventures, where the reporting entity is adventurer, key management personnel or the reporting entity or its parent, other related parties. So they're basically saying yes, there should be related party disclosures in the reporting entities books. But in addition to that, there would be a need for additional related party disclosures in effect on the other side of the transaction.

So if it's with a parent, if it's with an investor where we have influence, subsidiary associate, et cetera, or a key management personnel may be involved in two or three different businesses, the other side of the transaction should have a related party disclosure also. Looking at the SEC, actually it's regulation S-K, item 404, they have disclosure requirements. And item 404 itself has four parts. One, general disclosure requirements for related person transactions, including those involving debt. So they used the word related person, as well as related party. Disclosure regarding the company's policies and procedures for the review, approval and ratification of the related party transactions.

Now, policies and procedures suggest that a public company should have policies and procedures related to review approval and ratification of related party transactions. That's a requirement that the SEC has.

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Three, disclosures regarding promoters and certain control persons of the company. And four, corporate governance disclosure requirements and the independence of directors, all of that is within the context of item 404 within the SEC.

Now, certain terms are identified in item 404. One is a transaction. A registrant is a participant with any related person having a direct or indirect interest in the register. And a related person is defined as any person who is an executive officer or their immediate family or a security holder. So if you go back to the definition of transaction, the registrant is a participant with any related person. Any related person is any person who is an executive officer, whether immediate family or security holder in an amount above 120,000 or cumulative amount above 120,000. Meaning, disclosure is required for that kind of activity.

And the disclosure that's required is the person's name and relationship to the company. The person's interest in the transaction with the company, the approximate dollar value of the amount involved in the transaction and all the related persons interest in the transaction and any other information regarding the transaction or the related person in the context of the transaction that is material to investors in light of the circumstances of the particular transaction. In other words, why did you do it? What's the purpose of doing it? Generally speaking, we shouldn't be doing related party transactions or shouldn't be related persons with transaction activity. But if there are, tell us why you did it, tell us the purpose of doing it. What were you trying to accomplish and achieve? That's what these disclosures are.

In addition, that description of the material features of the company's policies and procedures for the review or approval or ratification of transactions with related persons. So again, there should be policies and procedures related to related parties for the review, approval or ratification of transactions. So the types of transactions covered by these policies and procedures

should be described person or groups on the board, or otherwise who are responsible for applying such policies and procedures and what these as policies and procedures are in writing, and if not, how such policies and procedures are communicated to others that should know what the policies and procedures are.

So let's move off of accounting and let's move into auditing. Keeping in mind now that accounting has certain base level requirements as it relates to related party disclosures. Management could elect not to make those disclosures, not to identify related party activity, not to identify related party transactions. And of course this would be misrepresenting those transactions in the financial statements, but management may have reasons for not wanting to disclose the nature of related party activity.

So we have that existing, even though we have accounting requirements to make certain disclosures. In the auditing area, the auditor has the responsibility to ensure that whatever related party activity has taken place that has been accounted for properly, that has been disclosed properly. The auditor has never had the requirement that is to date, to seek out and identify undisclosed related parties. That simply hasn't been a requirement. The auditor is required to as best possible, identify related party transactions either by having the client give those, communicate those to the auditor or the auditor might identify a situation through other auditing work he or she is doing that may suggest that there's a related party transaction here, and the auditor would of course follow up with that.

But again, to repeat, there's never been a requirement in the audit literature that says, the auditor should seek out and identify undisclosed related parties, meaning the auditor should perform procedures specifically to identify undisclosed related parties. Now, having said that... I said earlier that the auditing literature has been enhanced recently, and we're going to go over that. And while that literature still doesn't specifically say, the

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auditor must seek out and identify undisclosed related parties, it gets us a little bit closer to having a similar type of responsibility.

So the two areas of auditing or the auditing standard board and international auditing group, and they both have their guidance in section 550, related parties, although it's a little bit different and PCAOB AS 2410 on related parties. So the auditor's objective when we take a look at whether it's the auditing standards board or the international folks, the objectives are the same, to obtain an understanding of related party relationships and transactions sufficient to be able to recognize fraud risk factors and conclude whether the financial statements present fairly the results of those transactions.

So the first bullet says, obtain and understanding of related party relationships. Now that is different than seeking out and identifying undisclosed related parties. So that's not quite that far, but we need to understand related party relationships. What are they, why have you done them? What is the purpose? What is the scope of these, et cetera, et cetera. And as part of our overall risk assessment, we're looking all the time for potential fraud risk factors. And we're also looking for them in the area related parties.

Now, this does not mean we're doing a fraud audit, it simply means that we're identifying factors due to our understanding that may be fraud risk factors. And second bullet, obtain sufficient appropriate audit evidence about whether related party relationships and transactions have been appropriately identified, accounted for and disclosed in the financial statements. So we are required to gather audit evidence about related party activity, and we are required to make sure that it's been accounted for properly, and it's been disclosed properly. Again, I know I'm repeating myself. It does not require we seek out and identify undisclosed related parties, it does require that the related parties that we are aware of, the related party activity we are aware of, or that comes to our attention through work that we do is appropriately identified, accounted for and disclosed.

So looking at the area of risk assessment, which is what the auditing standards board and the international folks have been focusing on in recent years, there should be specific risk assessment procedures surrounding related parties. That would be inquiring, analytics, inspection of documents, observation of employee behavior and walk-throughs. And of course, probably the most significant of that is inquiries. And ultimately, as we'll see shortly, confirming inquiries, which is a new requirement now in audit literature.

So we perform risk assessment, hopefully, so that we can identify where there may be risk associated with the potential or possibility of related party transactions taking place. Identify and assess the risk of material misstatement that maybe associated with these related party relationships and create responses, which would be audit procedures to the risk of material misstatement associated with related party relationships and transactions. So the key thing we're looking at here is linkage. Assess risk as to where there may be related party activity, then develop audit procedures linked to that risk to help us either mitigate the risk or to identify where there may have been certain transactions, certain related party transactions.

Four, evaluation of the accounting for and disclosure of identified related party relationships and transactions. Make sure the debits and credits are appropriate for example, communication with those charged with governance about the nature of these, and then document the results of the auditing work that was done. So, yes, there are procedures that we're coming up with number three, what are the responses to the risk of material misstatement associated with related party relationships and transactions, responses or audit procedures?

But those audit procedures are going to be in the area of determining if the transaction was accounted for properly, whether it was disclosed properly, et cetera. And again, we're not going as far as seeking out and identifying, but the more we do this work, the more we may be likely to identify an undisclosed related party transaction.

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I said that the auditing standards board has brought us a little bit closer if you will, to seeking out and identifying. And that's with the issuance of SEC's 135 and 2019. SEC 135 changed section 550, related parties, and addresses the auditor's responsibility with regard to related party relationships and transactions. SEC 135 adds and specifically expands procedures. That's the key issue, expands procedures, to focus on the transactions and relationships of related parties in the following areas. And we're going to go over each of these on the next five or six slides.

Understanding of the entity and its environment, assessing the risk of material misstatement, performing audit procedures to respond to the risk, evaluating the audit evidence obtained and consideration of fraud related to the risk of misstatements. So look at this within the context of a related party. We have to develop a better understanding of the entity and its environment, assess the related party risk of material misstatement, perform audit procedures linked to those risk, evaluate the audit evidence obtained, and then as sort of an overlay, deal with the issue of fraud that may be associated, or maybe a result of related party activity.

Let's look at each one. Understanding the entity adds inquiries of not only management, but others within the entity. So there's going to be confirming inquiries now. So we speak with management, we gather information from them, then we go to others within the organization who would have information similar to that of which management was asked. And without telling them management's answers, ask the same questions and see if we get correct answers, corresponding answers, consistent answers.

So this is an attempt to initially identify where there may be some related party activity that either hasn't been disclosed or just is being ignored on purpose. So the inquiries include the nature of the related party relationships, including where there might be ownership involved with related parties, some background information, so we understand the environment

appropriately, physical location, industry size, extent of operation. Does the related party for example, actually exist, or are they in name only?

Three, the business purpose for which the related party entered into the transaction as opposed to an unrelated party. So if you have the opportunity to participate in the same transaction with an unrelated customer or vendor, why did you choose instead to use a related party for this transaction? What was the purpose?

And the question should be the business purpose for doing this. Plus in theory, there should be a better business purpose to participate in a related party transaction than in a non-related party transaction. Unless of course, you're somehow trying to manipulate the financial information of the reporting entity, any modifications or termination or transactions during the period and the type of business purpose for doing so. So we're basically looking at add, subtract, modify. Why did we do that?

The second, assessing the risk of material misstatement should now include inquiries related to whether any of the related party transactions have not been authorized in accordance with the entities, policies and procedures. So while a non-public company is not required to have policies and procedures as it specifically relates to related parties, they very well may have them, and as a best practice they should have known.

So taking a look at the risk of material misstatement, inquiries as to whether any of the related party transactions have not been authorized, had exceptions granted to whatever the policies and procedures are. And when granted exceptions, what were the reasons for doing so? All of this is, again, information gathering. The more information we have about related parties, the more likely we can ensure that they've been accounted for properly.

And performing audit procedures to respond to the risk of material misstatements. Remember, this is the linkage to the risks that may have been identified in a related party area. The

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auditor should evaluate the following, has the reporting entity properly identified it's related party relationships and transactions? And now this second bullet is brand new, to identify these relationships and transactions, has the auditor included procedures to test the accuracy and completeness?

So the auditor inquiries, and gets a list of related parties or related party transactions. The guidance now in the audit literature says, that list has to be tested for accuracy and completeness. Now, if you happen to be an auditor, I'll ask the rhetorical question. Do you commonly test for accuracy and completeness of the related party information given you by a client? I think the answer to that question is mixed. Some probably have done that in the past. I think many I really not done it. They basically took that list, then the way they tested it, so to speak, was to see if anything else came to their attention that might not have been on the list.

Now we have a requirement to test accuracy and completeness. So accuracy and completeness, is the list correct? And does it have everything on it that should be on it, accuracy and completeness? I think that's going to require some additional work in the related party area that may not have been done all the time in the past. Also in performing audit procedures, the auditors should evaluate the following, have procedures on balances with affiliated entities.

So here we're getting a specific type of procedure, with affiliated entities being considered as of concurrent dates, such as has the underlying document been read to determine the terms and information are consistent with explanations and other audit evidence? Has authorization been consistent with policies and procedures? Has the transaction been accounted for properly? Has adequate disclosure been made?

So specifically we need to look at other information now with affiliated entities. So even if there hasn't been any identified related party transaction, we still are going to look more closely at affiliated entities. Evaluating the audit evidence obtained requires the auditor to remain alert for

related party information when reviewing records or documents and consider the following, confirming the business purpose, taking into consideration though the likelihood that the entity, the reporting entity could influence to relate a party in the responses to the auditor and evaluating information about the financial capability of the parties to a transaction.

So does that related party exist? Do they have the ability to make payments if that's the case? Oftentimes we find related parties exist in name only. And then consideration of fraud related to the risk of misstatements notes that fraudulent financial reporting often involves management overriding controls that otherwise may appear to be operating effectively. So the key issue here is management override is often associated with related party activity by creating fictitious terms of transactions with related parties designed to misrepresent the business purpose of these transactions, frequently are fraudulently organizing the transfer of assets from or to management or others at amount significantly above or below market value, and engaging in complex transactions with related parties, such as entities formed will accomplish specific purposes that are structured to misrepresent the financial position or financial performance of the entity.

So that's a special purpose entity and we've seen companies set up another legal organization to, for example, take return goods where company A is recognized revenue, company B takes the goods back that are being returned for being damaged or for not functioning properly or whatever the reason is. And the second company that was set up borrows money guaranteed by the first company, company A, and then company B pays back the customers for the products they return from the borrowings that took place.

Then company A does not consolidate company B. So company A recognizes the revenue, but does not recognize the returns, does not recognize the cash outlays to pay for those returns. Again a special purpose entity structured to misrepresent the financial reporting of the reporting entity.

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There's also triggers that one can look at for related party transactions. And I have three screens here just to kind of quickly look at what may be triggers that suggest there may have been a related party transaction, even though it may not have been identified. Buying or selling goods and services at prices that differ significantly from prevailing market prices, sales transactions with unusual terms, including unusual rates of return or extended payment terms generally not offered to others, building whole type transactions, where you build a customer and hold the product, you don't ship it. Borrowing or lending on an interest free basis, where there are no fixed repayment terms. And that's not a normal business transaction. Occupying premises or receiving other assets or rendering or receiving management services when no consideration is exchanged. Engaging in a non-monetary transaction that lacks commercial substance.

Selling a building for a note receivable, and that note receivable will be unable to be paid, but you recognize a gain on the sale. Sales without economic substance. Loans to parties at the time in the loan transaction, do not have the ability to repay and possess insufficient or no collateral. Again, normal business practice is not to participate in that kind of transaction without collateral. So if you participate in a related party transaction, or if you participate in a no collateral transaction, it may very well be a related party transaction.

Loans made without prior consideration of the ability of the party to repay. A subsequent free purchase of goods that indicates at the time of the sale an implicit obligation of repurchase may have existed that would have precluded revenue recognition and sales treatment at that time. So we see sometimes a company will sell something, recognize revenue, then buy it back after the end of the reporting period. And they will still recognize the revenue. And that's a fraudulent transaction.

Events and company funds that are used directly or indirectly to pay what would

otherwise be an uncollectible loan or receivable. Also sales at below market rates to an intermediary whose involvement serves no apparent business purpose, but who in turn sells the ultimate customer at a higher price with the intermediary and probably some sharing of that higher price retaining the difference. Guarantees and guarantor relationships outside the normal course of business. Why are you guaranteeing something for another company? For example, transactions between two or more entities in which each party provides and receives the same or similar amounts of consideration.

So beyond those triggering events, we had PCAOB's requirement, AS 2410, related parties, and their requirements are almost identical to the auditing standard boards requirements in that, you must first perform a risk assessment. So perform risk assessment procedures to obtain an understanding of the company's relationships and transactions with its related parties, including inquiries. So risk assessment, again, inquiries, analytics, inspection of documents, observation of employee behavior, walk-throughs, all designed to identify whether there may be some risk associated with related party activity.

Two, identify and assess risk of material misstatement. Three, respond to the risk of material misstatement. And one of the responses might be, do the related parties have the financial ability to perform. All right. So we're linking again, the risk identified to the procedures performed to mitigate that risk. Four, evaluating whether the company has properly identified its related parties and relationships and transactions with related parties.

So again, we have the issue in the auditing standard world literature, accuracy and completeness for does it use those words, but have we properly identified its related parties and relationships and transactions? What has the company done in other words to do this, to identify these? Evaluate the accounting and disclosure, and then communicate with the audit

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committee the nature of these types of transactions. So PCAOB's requirements.

I indicated earlier that I wanted just to mention this to you, this AICPA practice aid, accounting and auditing for related parties and related party transactions. This is a useful tool. Has numerous checklists that one can use to identify or try to identify and account for and disclose a related party transactions. It's a useful tool AICPA has made available and in situations where a company or an auditor may want to look at the related party issue more in depth, this AICPA practice aid, I think it can be very, very useful.

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tSURRAN: Related party transactions seem to be a recurring issue, and the reason is

primarily two-fold.

One, there's been a significant amount of related party frauds that were discovered only after the fact. And two, there's been criticism of related party disclosures in that they don't provide an accurate view of the related party activity that took place within the reporting entity.

The accounting and auditing standard setters and the audit standard setters have enhanced their related party guidance in the area of performing risk assessment procedures to identify related parties and related party transactions. They've also enhanced audit procedures to permit the auditor to identify related party activity in a more meaningful manner.

WILLIAMS: Identifying related party relationships and related transactions is not as straightforward as one might think. John Fleming, CPA, discussion leader at Kaplan Financial Education, focuses on the importance of such transactions and illustrates a few fraudulent cases and their impact on the fair representation of financial statements.

FLEMING: So when we think of related parties, we have related parties as individuals or as entities that are not necessarily involved in arm's length transactions with the reporting entity. There may be related party transactions. If so, there's a requirement for related party disclosures and in addition to that, there is audit literature related to identifying the reasonableness overlay to party activity, the purposes of it, has it been accounted for properly, et cetera.

I think it may make sense to look at what some entities have actually done. The Baptist Foundation of Arizona was an arm of the Baptist Church. They had outsourced the management of their contributions. They outsourced the investing of those contributions, and the management group fraudulently established a number of fraudulent not-for-profit organizations, then made distributions to those not-for-profit organizations. And those distributions ended up in the hands of the management of the foundation.

So they used fraudulent related parties to deposit funds that in turn were given to the managers of the folks who were running the foundation, using in effect a related party, a fraudulent not-for-profit.

Adelphia Communications, the CEO's wife, had an office supply company and Adelphia mandated that all supplies had to be purchased from her company. She grossly overstated the pricing of supplies that Adelphia was paying the CEO's wife or let's say the CEO's family, substantial dollars for products that could have been purchased elsewhere at far less.

Rite Aid, a couple of the directors own property. They sold the property to Rite Aid at inflated prices as locations for Rite Aid to build a store.

Boston Scientific overpriced product that was selling to related party customers and then there was a sharing of that overpricing with folks at Boston Scientific and the related party customers.

Video Transcript

3. Related Party Transactions – A Recurring Issue

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t AIG paid out fraudulent claims to related parties. And then there was again a sharing of these fraudulent claims.

Lernout & Hauspie established false vendors, I'm sorry, false customers throughout Asia. They were allegedly selling technology to those customers and recording revenue based upon those sales, when the reality is those companies did not exist.

Parmalat borrowed billions of dollars from a related party bank, never recorded the borrowings as borrowings. They were recorded as sales and the paybacks were not recognized on the books of Parmalat.

WILLIAMS: There has been a number of related party frauds, none of which were discovered at the time the activity took place, whether by a whistleblower, an SEC investigation or an employee. They all resulted in significant financial statement misstatements. But is the accounting guidance sufficient? John elaborates.

FLEMING: So the related party literature consists of a number of different, or comes from a number of different groups. FASB has guidance in topic 850, related party disclosures. We'll look at that first. The IASB has IAS 24 related party disclosures. The SEC regulation S-K is item 404, certain relationships and related transactions. PCAOB is AS 2410, on related parties. The Auditing Standards Board and the international auditing folks have section 550 on related parties. It's a little bit different, but the same numbering. And AICPA has established a practice aid called accounting and auditing for related parties and related party transactions.

Let's look at some of the accounting issues first. We have FASB topic 850 in related party disclosures, IASB-IAS-24 on related party disclosures. And the SEC item 404, certain relationships in related transactions.

So the first one Topic 850. Topic 850 defines a related party as a business or personal arrangement between two parties. They could be entities, they could be individuals, who have a prior or existing relationship that can result in preferential benefits for one or both parties. I might add that it normally benefits both parties somehow.

WILLIAMS: When a $74 billion accounting and corporate fraud was unraveled at Enron that led to its bankruptcy, the world was in disbelief that a company such as Enron was able to set up several related entities that were not properly disclosed.

FLEMING: Years ago, there was a case with a company called Enron, where they established false companies, fraudulent companies that existed in name only. These companies borrowed money from banks Enron guaranteed the borrowing. So the banks provided the money to these in effect paper companies.

Then the paper company took the borrowings and transferred it to Enron and Enron recognized the borrowings as sales, overstating revenue by billions and billions of dollars. So who benefited from all this? The people that were involved in establishing these off-balance-sheet entities that existed in name only, they were the people who benefited because they were getting bonuses based upon revenue growth. So by using this off balance sheet related party, they were able to overstate revenue in Enron's books and as a result, cash out with performance bonuses that they allegedly earned.

WILLIAMS: John gives us the definition of related parties and some examples.

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t FLEMING: That related party definition includes affiliates being identified as related parties, equity method investments, and remember that they exist when you have between 20% and 50% ownership in a company. So you have significant influence, in other words, trust for the benefit of employees, principal owners of the entity and members that are immediate families, that's mother, father, brother, sister, son, daughter, management of the entity and members of their immediate families, and any party that controls or can significantly influence the management or operating policies to the extent that one party might be prevented from fully pursuing its own separate interest.

We see control happening sometimes through an agreement or through a contract, where a reporting entity is interested in obtaining something that can help it be better at what it does, but they can't get that or do that without permission from another entity. So the other entity to protect its interest may require that for a period of time, they have control or influence over the operating activities of the reporting entity. And if that's the case, that would clearly be a definition of related party.

WILLIAMS: So what are the disclosure requirements under Topic 850?

FLEMING: The disclosures required by topic 850, by FASB, include the following, the nature of the relationships, description of the transactions, dollar amount of the transactions during each period presented, changes in the terms of transactions from year to year, if those changes take place, the receivable or payable balances at the balance sheet date, and they should either be on the face of the balance sheet or in a note disclosure. Settlement terms or receivables or payables, if not obvious, and the nature of any control relationships, if that should exist.

Now, this note disclosure, while it has seven points to it, oftentimes the company makes this note disclosure in a paragraph or two. It's often not a lengthy note. So the nature of relationship between company A and B, description was a purchase or sale or guarantee, the dollar amount was for $1 million. Maybe there was no change in terms, the balance is reported on the balance sheet, the settlement terms were identified, and there may or may not be control relationships. The point being that this is not usually a lengthy note. And if it happens to be a related party fraudulent transaction, then this note is not even written, it's not even presented.

WILLIAMS: John discusses the impact of related party frauds not discovered timely and the adequacy of related party disclosures.

FLEMING: When a company participates in a related party fraud, they don't disclose it. They don't highlight it in their financial information.

The first issue is in terms of recurring issues, related party frauds that are not discovered till after the fact, the second issue is the adequacy of related party disclosures. And topic 850 has everything covered as long as we're not talking about a fraudulent transaction.

In some instances, even if it's not fraud, the company chooses not to disclose related parties and they choose not to disclose them because they don't want others to know about the related party activity that's in place. While FASB says, this is what you should disclose, it doesn't necessarily mean that's what gets disclosed if a company wants to hide related party transactions from outsiders.

Other related party disclosure areas may show up in the equity method, investment note, in a guarantee note, in an equity note, in a debt note in a business combination note, in a consolidation note, or a franchise note,

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t limited liability, LLC, LLP entities, or where there may be some control relationships that have to be disclosed. So we've got the basic related party disclosure in topic 850, and then there may be additional commentary on related parties in other notes, due to the nature of some activity that may be taking place in that type of transaction.

WILLIAMS: John talks about the IAS 24 definition of related party and how it might differ from the one under FASB.

FLEMING: IAS 24, its related party definition is not terribly different from FASB's related party definition. It is persons or entities that are related to the entity, the reporting entity, that is preparing its financial statements. So we're looking at, just as FASB does, related party people or related party entities that participate in some type of transaction where one or more tends to benefit from that related party transaction.

The IAS 24 goes on to expand this definition, just like FASB expanded its definition, to indicate that a person or close member to that person's family, who controls or generally controls or has significant influence over the reporting entity, that's the related party. That person or close family member is a related party. A person or a close member of the person's family who was part of key management personnel of the reporting entity or the reporting entity's parent. Ownership and close family members of the ownership. Management and close family members of management.

An entity that is a member of the same group in which the reporting entity is also a member and GAAP refers to that as an affiliated organization. An entity that is an associate or joint venture of the reporting entity or vice versa. IAS 24 goes on to say, as part of its related party definition, an entity that is a member of a joint venture, which the reporting entity is a venture. An entity that is a joint venture with a third party, obviously a reporting entity is an associate of that third party. An entity that has a post-employment benefit plan for the benefit of employees or the reporting entity or the entity related to the reporting entity. So in US GAAP, that would be a pension or post-employment plan. Internationally it's a post-employment plan.

WILLIAMS: But are the related party disclosures different under IAS 24?

FLEMING: The related party disclosures in IAS 24 include the following: the nature of any parent subsidiary relationship, even as there has been no related party transaction. Now that note in FASB might be in the consolidation note more than the related party note.

Key management compensation. This is something not required by FASB. To some degree it is required by the SEC, but the IAS requires management compensation being included in its related party note. And for this reason related party notes internationally are normally a bit longer than related party notes required by FASB.

The description of any related party transactions such as purchases, sales, leases, guarantees, again, same as FASB. The amount of any related party transaction during the reporting period same as FASB, provisions of any uncollectible receivables related to the amount of outstanding balances. In FASB we would normally see that in the receivable note.

The expense recognized during the period for bad or doubtful debts due from related parties. Again, you would normally see that in the receivable note in FASB. Then separate disclosures will be made for each of the

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t following: there would be disclosures of the parents, entities with joint control or influence, subsidiaries, associates, joint ventures, where the reporting entity is a venture, key management personnel or the reporting entity or its parent, other related parties.

So they're basically saying yes, there should be related party disclosures in the reporting entity's books. But in addition to that, there would be a need for additional related party disclosures in effect on the other side of the transaction. So if it's with a parent, if it's with an investee where we have influence, subsidiary associate, et cetera, or a key management personnel may be involved in two or three different businesses, the other side of the transaction should have a related party disclosure also.

SURRAN: In March 2007, the SEC posted new interpretations on regulation S-K, item 404, Transactions with Related Persons, Promoters and Certain Control Persons, replacing the July 1997 Manual of Publicly Available Telephone Interpretations and March 1999 Supplement.

Item 404(a), Transactions with Related Persons, discusses disclosure requirements. According to the SEC, disclosure is required if the transaction was continuing (such as through the ongoing receipt of payments) after the date the person became a 5% shareholder or it resulted in the person becoming a 5% shareholder. If the transaction concluded before the person became a 5% shareholder, disclosure would not be required.

WILLIAMS: John Fleming elaborates further on the SEC disclosure requirements under Regulation S-K item 404.

FLEMING: Looking at the SEC, actually it's regulation S-K, item 404, they have disclosure requirements. And item 404 itself has four parts. One, general disclosure requirements for related person transactions, including those involving debt. So they used the word related person, as well as related party.

Disclosure regarding the company's policies and procedures for the review, approval and ratification of the related party transactions. Now, policies and procedures suggesting that a public company should have policies and procedures related to review approval and ratification of related party transactions. That's a requirement that the SEC has.

Three, disclosures regarding promoters and certain control persons of the company.

And four, corporate governance disclosure requirements and the independence of directors, all of that is within the context of item 404 within the SEC.

Now, certain terms are identified in item 404. One is a transaction. A registrant is a participant with any related person having a direct or indirect interest in the register. And a related person is defined as any person who is an executive officer or their immediate family or a security holder.

So if you go back to the definition of transaction, a registrant is a participant with any related person. Any related person is any person who is an executive officer, whether immediate family or security holder in an amount above 120,000 or cumulative amount above 120,000. Meaning, disclosure is required for that kind of activity. And the disclosure that's required is the person's name and relationship to the company. The person's interest in the transaction with the company, the approximate

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t dollar value of the amount involved in the transaction and all the related persons' interest in the transaction and any other information regarding the transaction or the related person in the context of the transaction that is material to investors in light of the circumstances of the particular transaction. In other words, why did you do it? What's the purpose of doing it?

WILLIAMS: John discusses the nature of transactions covered by policies and procedures.

FLEMING: In addition, that description of the material features of the company's policies and procedures for the review or approval or ratification of transactions with related persons. Again, there should be policies and procedures related to related parties for the review, approval or ratification of transactions. The types of transactions covered by these policies and procedures should be described, person or groups on the board, or otherwise who are responsible for applying such policies and procedures and what these as policies and procedures are in writing, and if not, how such policies and procedures are communicated to others that should know what the policies and procedures are.

SURRAN: On the accounting side, there are certain base level requirements for related party disclosures. Management could elect not to make those disclosures, not to identify related party activity, or not to identify related party transactions. Even though management may have reasons for not wanting to disclose the nature of such related party activity, the financial statements would be misrepresented with respect to those transactions.

Auditors, on the other hand, have the responsibility to ensure that whatever related party activity has taken place has been accounted for properly, and has been disclosed properly. The auditor is required to, as best possible, identify related party transactions either by having the client disclose those, communicate those to the auditor or the auditor might identify a situation through other auditing work he or she is doing that may suggest that there's a related party transaction, and the auditor would of course follow up with that.

WILLIAMS: It seems though that the auditor's responsibilities have changed and even though it may be specifically noted in the auditing literature, it may be implied that auditors may be responsible in seeking out related party transactions.

FLEMING: There's never been a requirement in the audit literature that says the auditor should seek out and identify undisclosed related parties, meaning the auditor should perform procedures specifically to identify undisclosed related parties. And while that literature still doesn't specifically say, the auditor must seek out and identify undisclosed related parties, it gets us a little bit closer to having a similar type of responsibility.

So the two areas of auditing are the auditing standard board and international auditing group, and they both have their guidance in section 550, related parties, although it's a little bit different and PCAOB AS 2410 on related parties. So the auditor's objective when we take a look at whether it's the auditing standards board or the international folks, the objectives are the same, to obtain an understanding of related party relationships and transactions sufficient to be able to recognize fraud risk factors and conclude whether the financial statements present fairly the results of those transactions.

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t Obtain an understanding of related party relationships. Now that is different from seeking out and identifying undisclosed related parties. That's not quite that far, but we need to understand related party relationships. What are they? Why have you done them? What is the purpose? What is the scope of these, et cetera. As part of our overall risk assessment, we're looking all the time for potential fraud risk factors. We're also looking for them in the area related parties. Now, this does not mean we're doing a fraud audit, it simply means that we're identifying factors due to our understanding that there may be fraud risk factors.

Obtain sufficient appropriate audit evidence about whether related party relationships and transactions have been appropriately identified, accounted for and disclosed in the financial statements. We are required to gather audit evidence about related party activity, and we are required to make sure that it's been accounted for properly, and it's been disclosed properly.

SURRAN: Assessing the risk of material misstatement should now include inquiries related to whether any of the related party transactions have not been authorized in accordance with the entity's policies and procedures. So while a non-public company is not required to have policies and procedures as it specifically relates to related parties, they may very well have them as a best practice.

Taking a look at the risk of material misstatement, inquiries are made as to whether any of the related party transactions have not been authorized, had exceptions granted to whatever the policies and procedures are, and when granted exceptions, the reasons for doing so. All of this is information gathering. The more information we have about related parties, the more likely that we can ensure that they've been accounted for and properly disclosed.

WILLIAMS: John Fleming discusses the link between performing audit procedures to respond to the risk of material misstatement and the risk identified in the area of related parties.

FLEMING: Performing audit procedures to respond to the risk of material misstatements. Remember, this is the linkage to the risks that may have been identified in a related party area. The auditor should evaluate the following – has the reporting entity properly identified it's related party relationships and transactions. Has the auditor included procedures to test the accuracy and completeness?

So the auditor inquires, gets a list of related parties or related party transactions. The guidance now in the audit literature says, that list has to be tested for accuracy and completeness. Now, if you happen to be an auditor, I'll ask the rhetorical question. Do you commonly test for accuracy and completeness of the related party information given you by a client? I think the answer to that question is mixed. Some probably have done that in the past. I think many have really not done it. They basically took that list, then the way they tested it, so to speak, was to see if anything else came to their attention that might not have been on the list.

WILLIAMS: So how do you test for accuracy and completeness?

FLEMING: Now we have a requirement to test accuracy and completeness. So accuracy and completeness, is the list correct? Does it have everything on it that should be on it, accuracy and completeness? I think that's going to require some additional work in the related party area that may not have been done all the time in the past.

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t Also in performing audit procedures, the auditors should evaluate the following, have procedures on balances with affiliated entities. So here we're getting a specific type of procedure, with affiliated entities being considered as of concurrent dates, such as has the underlying document been read to determine the terms and information are consistent with explanations and other audit evidence? Has authorization been consistent with policies and procedures? Has the transaction been accounted for properly? Has adequate disclosure been made?

So specifically we need to look at other information now with affiliated entities. So even if there hasn't been any identified related party transaction, we still are going to look more closely at affiliated entities.

WILLIAMS: John discusses the evaluation process of evidence obtained and testing considerations.

FLEMING: Evaluating the audit evidence obtained requires the auditor to remain alert for related party information when reviewing records or documents and consider the following, confirming the business purpose, taking into consideration though the likelihood that the entity, the reporting entity could influence the relate party in the responses to the auditor and evaluating information about the financial capability of the parties to a transaction.

So does that related party exist? Do they have the ability to make payments if that's the case? Oftentimes we find related parties exist in name only.

And then consideration of fraud related to the risk of misstatements. Notice that fraudulent financial reporting often involves management overriding controls that otherwise may appear to be operating effectively.

So the key issue here is management override is often associated with related party activity. By creating fictitious terms of transactions with related parties designed to misrepresent the business purpose of these transactions, frequently or fraudulently organizing the transfer of assets from or to management or others at an amount significantly above or below market value, and engaging in complex transactions with related parties, such as entities formed will accomplish specific purposes that are structured to misrepresent the financial position or financial performance of the entity.

WILLIAMS: John explains special purpose entities and how they should be treated in the financial statements.

FLEMING: That's a special purpose entity and we've seen companies set up another legal organization to, for example, take return goods where company A has recognized revenue, company B takes the goods back that are being returned for being damaged or for not functioning properly or whatever the reason is. And the second company that was set up borrows money guaranteed by the first company, company A, and then company B pays back the customers for the products they return from the borrowings that took place. Then company A does not consolidate company B. So company A recognizes the revenue, but does not recognize the returns, does not recognize the cash outlays to pay for those returns.

Again a special purpose entity structured to misrepresent the financial reporting of the reporting entity.

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4. IRS Updates

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

November 6, 2022

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

“Premium Assistance for COBRA Benefits Part II”

“Tax Credits for Paid Leave Under the American Rescue Plan Act of 2021 for Leave After March 31, 2021”

See page 4–12.

See page 4–22.

33 minutes

Subsequent to the March 2020 emergency declaration issued by President Trump in response to the coronavirus pandemic, there have been several major disaster relief declarations. As the pandemic seems like it’s never ending, the IRS has to plan accordingly and extend most of its tax treatments with respect to COVID-19 and/or provide additional guidance where necessary. Barbara Weltman, president of Big Ideas for Small Business, gives us COVID-19 related IRS updates, discusses the tax treatment of recent tax cases, and explores ways tax professionals can boost their data security and better protect client information.

Learning Objectives:

Upon successful completion of this segment, you should be able to:

l Identify the updates to the leave-based donations program and COBRA premium assistance,

l Understand the tax treatment of different types of damages, l Recognize substantiation requirements to support medical

expenses, and the difference between real-time and automatic substantiation, and

l Determine steps tax professionals should take in order to boost their data security and better protect their clients.

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A. Leave-based Donation Program 2021 Extension

i. Employees may l Contribute unused leave time l Remain taxed on donated leave

ii. Employers may l Make a cash equivalent donation

of leave time l IRS approved charity l Before January 1, 2022 l Benefit of COVID-19 relief l Employees are not taxed on their

donation

B. Employer Obligations – COBRA

i. Must provide premium assistance l Applicable to involuntarily

terminated employees l April 1, 2021 through September

30, 2021

ii. IRS provided Q&A

C. COBRA Eligibility Premium Assistance Ends

i. Eligible individual is covered under l Disqualifying group health plan l Medicare

ii. All benefits provided by COBRA l Even if NOT covered by new

plan

D. Conditions to Claim Premium Assistance Credit

i. Employers need to l Participate in a SHOP exchange l Receive a single premium

invoice l Aggregate all premium payments l Pay premium to insurers l Have a contractual obligation

with SHOP exchange l Receive the state mini COBRA

premiums directly

I. American Rescue Plan Changes

A. NOL Election Deemed Election If

i. Taxpayer filed before December 27, 2020

ii. Original or amended federal income tax return

iii. Applications for tentative refunds

B. Remember

i. Payments received do not have to be reported on 2021 returns

ii. Recovery rebate credit may still be claimed

II. Extension of Paid Sick Leave and Loss Carrybacks

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A. Treatment of Compensatory Damages

i. Taxable l Damages from lawsuits l Damages from defamation

ii. Tax free l Damages from personal physical

injury or sickness l Damages from medical

malpractice

B. Malpractice Settlement Terms

i. Exchange for the release of claims against the attorney

ii. Not relevant to marital property

III. Taxability of Lost Compensation

A. Substantiation Requirements

i. Description of product or service

ii. Date of service or sale

iii. Amount spent

B. Real-Time Substantiation

i. Independent third-party verification at the point and time of sale

C. Automatic Substantiation

i. Payment of recurring medical expenses previously approved

D. Dependent Care FSAs

i. Expenses of the care of qualified individuals are reimbursable

ii. Taxpayer’s child age limit increased in 2020

iii. Virtual daycare & in-person daycare should be treated the same l Enables parents to work

IV. Medical and Care Expenses

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Outline (continued)

A. Individual Online Tax Account Includes

i. Access to amounts owed, balance details & payment history

ii. Key information from most recent tax returns

iii. Digital copies of selected notices

iv. Economic impact payments

v. Online payment & payment plan options

vi. Access to tax records

B. Recommendations for Tax Professionals

i. Boost data security

ii. Establish multi factor authentication l Tax preparation software

accounts

iii. Sign up clients for identity protection PINs

iv. Help clients l Fight unemployment

compensation fraud l Avoid spear phishing scams

v. Know the signs of identity theft

“…tax-related identity theft continues to climb. This has been exacerbated by the pandemic, with more employees working remotely and more fraudsters using new scams and schemes.”

— Barbara Weltman

V. Looking Forward

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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 gives us COVID-19 related IRS updates, discusses the tax treatment of recent tax cases, and explores ways tax professionals can boost their data security and better protect client information.”

l Show Segment 4. The transcript of this video starts on page 4–22 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 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. IRS Updates

1. Federal leave-based donation programs allow employees to forgo vacation, sick, or personal leave in exchange for cash payments made by their employer to charitable organizations. What are the tax implications of such programs? Has your organization utilized such a program?

2. The COVID-19 pandemic has had an effect on the tax rules surrounding health plans. How have employers been impacted by the rule changes? How have these changes impacted you and your organization?

3. Recent tax laws have created confusion surrounding the deductibility of net operating losses (NOLs) for certain businesses, including, specifically, farming businesses. What are the current rules for deducting NOLs? How has your organization dealt with the changes?

4. Compensatory damages received from litigation receive special tax treatment by the IRS. What are the rules surrounding the receipt of damages? Do you agree with the treatment afforded to damages? Why or why not?

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. Medical expenses, like all other

deductions, require substantiation and support in order to be deductible. What are some issues surrounding the deductibility of medical expenses? How does your organization seek compliance with the substantiation rules?

6. The IRS has recently issued many new forms, some of which have resulted in filing confusion. What are the issues surrounding these new forms? How have these forms impacted your firm’s filing requirements?

7. Business and personal data are subject to cybersecurity threats. What has the IRS done to deal with these threats? What steps has your organization taken to protect its sensitive data?

Discussion Questions (continued)

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Suggested Answers to Discussion Questions

4. IRS Updates

1. Federal leave-based donation programs allow employees to forgo vacation, sick, or personal leave in exchange for cash payments made by their employer to charitable organizations. What are the tax implications of such programs? Has your organization utilized such a program? l Initial Notice 2020-46, modified by

Notice 2021-42 b Provided guidance on the federal

income and employment tax treatment to employers and their employees v For cash payments made

before January 1, 2021, for the relief of victims of COVID-19

l Leave-Based Donation Program 2021 Extension b Generally, employees may

contribute unused leave time v Employees are taxed on

donated leave b For 2021

v Employers may make a cash equivalent donation of leave time k To an IRS approved charity k Before January 1, 2022 k For the benefit of COVID-

19 relief v Employees are not taxed on

the donation v Employers can take a

charitable deduction l Participant response based on

personal/organizational experience

2. The COVID-19 pandemic has had an effect on the tax rules surrounding health plans. How have employers been impacted by the rule changes? How have these changes impacted you and your organization?

l Employer obligations under COBRA b Must provide premium assistance

v Applicable to involuntarily terminated employees

v April 1, 2021 through September 30, 2021

b IRS provided Q&A on 11 specific questions

l COBRA eligibility premium assistance ends b When eligible individual is

covered under v Disqualifying group health

plan OR v Medicare

l All Benefits provided by COBRA b Even if NOT covered by new

plan l Fully insured plans not subject to

COBRA offered through a small business health options program (SHOP) b Per the IRS, the employer is the

premium payee entitled to claim the premium assistance credit so long as four conditions are met: v Employers participate in a

SHOP exchange v Receive a single premium

invoice v Aggregate all premium

payments k Pay premium to insurers k Have a contractual

obligation with SHOP exchange

b Receive the state mini-COBRA premiums directly

l Participant response based on personal/organizational experience

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Suggested Answers to Discussion Questions (continued)3. Recent tax laws have created confusion

surrounding the deductibility of net operating losses (NOLs) for certain businesses, including, specifically, farming businesses. What are the current rules for deducting NOLs? How has your organization dealt with the changes? l 2017 Tax Cut and Jobs Act (TCJA)

b Disallowed NOL carrybacks b Except for farming businesses

v Allowed a two-year carry back l 2021 CARES Act

b Created a five-year carry-back for ALL businesses for NOL arising in 2018, 2019 and 2020

l IRS has issued guidance on when and how to make an election with regard to all taxpayer NOLs b NOL election deemed made if

v Taxpayer filed before December 27, 2020 k Original or amended federal

income tax return k Applications for tentative

refunds l Participant response based on

personal/organizational experience

4. Compensatory damages received from litigation receive special tax treatment by the IRS. What are the rules surrounding the receipt of damages? Do you agree with the treatment afforded to damages? Why or why not? l Treatment of Compensatory

Damages b Taxable

v Damages from lawsuits v Damages from defamation

b Tax free v Damages from personal

physical injury or sickness v Damages from medical

malpractice

l Recent case involving a settlement from malpractice case b Amounts received by the taxpayer

were taxable because v Exchange for the release of

claims against the attorney v Not relevant to marital

property l Participant response based on

personal/organizational experience

5. Medical expenses, like all other deductions, require substantiation and support in order to be deductible. What are some issues surrounding the deductibility of medical expenses? How does your organization seek compliance with the substantiation rules? l Medical expenses paid by a debit

card tied to a health FSA require b Description of product or service b Date of service or sale b Amount spent

l If the debit card doesn't show the specific items or services b The FSA plan administrator must

request more information from the employee

b An independent third party must provide the employer with a statement verifying the medical expense v Automatically or v After the transaction

l Automatic Substantiation b Payment of recurring expenses for

medical expenses previously approved v That match the amount,

medical care provider and time period of previously approved expenses can be approved without additional substantiation

l Participant response based on personal/organizational experience.

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Suggested Answers to Discussion Questions (continued)

6. The IRS has recently issued many new forms, some of which have resulted in filing confusion. What are the issues surrounding these new forms? How have these forms impacted your firm’s filing requirements? l IRS has created separate forms for

partnerships and S-corporations with foreign activities. b Prior to 2021 such activities

reported on line 14 of schedule K-1

b For 2021 returns, entities with no foreign activities don't have to report anything on K-1 v Schedule K-2 is for

information about items at the entity level

v Schedule K-3 is for the onus of the distributive share of these items.

v Both draft forms and draft instructions are available

b The IRS has said it would provide penalty relief for K-2s and K-3s for 2021 returns

l Draft forms of the 1040 b Basically, the same as the 2020

versions b Schedule 3 is two pages b Dependent care credit now in part

two of schedule 3 for refundable credits

b The charitable contribution deduction for non-itemizing taxpayers is taken as the QBI deduction, along with the standard deduction amount.

l Participant response based on personal/organizational experience

7. Business and personal data are subject to cybersecurity threats. What has the IRS done to deal with these threats? What steps has your organization taken to protect its sensitive data? l IRS is teaming up with state tax

agencies and the tax industry to raise awareness among tax professionals about data security b Tax-related identity theft however

continues to climb b Exacerbated by the pandemic,

with more employees working remotely and more fraudsters using new scams and schemes

l Recommendations for tax professionals b Boost data security b Establish multi factor

authentication v Tax preparation software

accounts b Sign up clients for identity

protection PINs b Help clients

v Fight unemployment compensation fraud

v Avoid spear phishing scams b Know the signs of identity theft

l Participant response based on personal/organizational experience

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1. The current rules governing employee leave based donation programs:

a) allow employers to take a charitable contribution for employee donations of leave time

b) require employees to include donated leave time in their wages

c) allow employees to take a charitable contribution for donations of leave time

d) do NOT allow any deductions for donations of unused leave time

2. A taxpayer’s eligibility for COBRA premium assistance ends when the individual becomes eligible coverage under:

a) Medicare only

b) a disqualifying group health plan other than Medicare only

c) another disqualifying group health plan or Medicare

d) Social Security

3. With respect to the third round of Economic Impact Payments (EIPs):

a) payments received must be reported on recipients’ 2021 returns

b) payments received must be reported on recipients’ 2020 returns

c) payments received do NOT have to reported on recipients’ 2021 returns

d) payments received need ever be reported by recipients

4. Which of the following type of damages received is taxable to the recipient?

a) damages from personal injury

b) damages from lawsuits

c) damages from medical malpractice

d) damages from physical sickness

5. A charitable donation over ______ requires a copy of a qualified appraisal to be attached to the return.

a) $500,000

b) $50,000

c) $5,000

d) $500

6. Under ______ substantiation method(s), independent third-party verification of a claimed expense must be provided at the point and time of sale.

a) both the automatic and real time

b) IRS deduction

c) automatic

d) real time

7. Current rules allow for the expenses of a taxpayer’s child up to the age of ___ to be reimbursable.

a) 13

b) 14

c) 18

d) 21

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. IRS Updates

Objective Questions

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8. Which of the following is NOT a recommendation for tax professionals concerned with data breaches and cyber security?

a) boost data security

b) establish multi factor authentication

c) file only paper returns on behalf of their clients

d) sign up clients for identity protection PINS

9. Employers may claim a tax credit of ______ for any employee who is unable to work due to the COVID-19 virus.

a) the higher of 80 hours of paid sick leave or any applicable federal, state or local minimum wage

b) only up to 80 hours of paid sick leave at the employee's regular rate of pay

c) only the applicable federal or state or local minimum wage

d) the lower of 80 hours of paid sick leave at the employee's regular rate of pay, or the Federal minimum wage

10. Under the American Rescue Plan Act of 2021 (ARP), employers are entitled to a ____ for qualified family leave wages paid to employees.

a) phased out deduction

b) full deduction

c) nonrefundable tax credit

d) fully refundable tax credit

Objective Questions (continued)

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Self-Study Option

Reading (Optional for Group Study)

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PREMIUM ASSISTANCE FOR COBRA BENEFITS PART II

Source: https://www.irs.gov/pub/irs-drop/n-21-46.pdf

Notice 2021-46 This notice provides additional guidance on the application of § 9501 of the American Rescue Plan Act of 2021 (the ARP), Pub. L. 117-2, 135 Stat. 4 (March 11, 2021), relating to temporary premium assistance for Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) continuation coverage.1

BACKGROUND Following enactment of the ARP, the IRS addressed issues with respect to COBRA premium assistance for COBRA continuation coverage under the ARP in Notice 2021-31, 2021-23 IRB 1173. This notice supplements Notice 2021-31 and addresses additional issues. Terms used in this notice have the same meanings as those terms have in Notice 2021-31, unless indicated otherwise.

ELIGIBILITY FOR COBRA PREMIUM ASSISTANCE – EXTENDED COVERAGE PERIODS

Q-1. Is COBRA premium assistance available for a potential Assistance Eligible Individual whose original 18-month COBRA continuation coverage period has expired, but who is entitled to notify the plan or insurer, and has not yet done so, of the intent to elect COBRA continuation coverage for an extended period due to a disability determination, second qualifying event, or an extension under State mini-COBRA, to the extent the extended period of coverage falls between April 1, 2021 and September 30, 2021?

A-1. Yes. If the original qualifying event was a reduction in hours or an involuntary termination of employment, COBRA premium assistance is available to an individual who is entitled to elect COBRA continuation coverage for an extended period due to a disability determination, second qualifying event, or an extension under State mini-COBRA, to the extent the extended period of coverage falls between

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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April 1, 2021 and September 30, 2021, even if the individual had not notified the plan or insurer of the intent to elect extended COBRA continuation coverage before the start of that period.

Example: An individual who was provided a COBRA general notice is involuntarily terminated and elects COBRA continuation coverage effective October 1, 2019; the individual’s 18-month COBRA continuation period lapses March 31, 2021. On March 1, 2020, a disability determination letter is issued by the Social Security Administration providing that the individual was disabled as of November 1, 2019. The disability determination entitles the individual to the 29-month extended COBRA continuation coverage. The individual fails to notify the plan of the disability determination by April 30, 2020, which is 60 days after the date of the issuance of the disability determination letter as required under § 4980B(f)(6)(C). However, under the Emergency Relief Notices, the individual has one year and 60 days from the issuance of the disability determination letter to notify the plan of the disability to extend COBRA continuation coverage. On April 10, 2021, the individual notifies the plan of the disability and elects ongoing coverage from April 1, 2021. Assuming the individual is not eligible for other disqualifying group health plan coverage or Medicare, the individual is an Assistance Eligible Individual and is entitled to the COBRA premium assistance.

END OF COBRA PREMIUM ASSISTANCE PERIOD – DENTAL AND VISION COVERAGE Q-2. If an Assistance Eligible Individual previously elected COBRA continuation coverage with premium assistance for dental-only or vision-only coverage, does the individual cease to be eligible for COBRA premium assistance if the individual subsequently becomes eligible to enroll in other disqualifying group health

plan coverage or Medicare that does not provide dental or vision benefits?

A-2. Yes. Eligibility for COBRA premium assistance ends when the Assistance Eligible Individual becomes eligible for coverage under any other disqualifying group health plan or Medicare, even if the other coverage does not include all of the benefits provided by the previously elected COBRA continuation coverage. For example, eligibility for Medicare, which generally does not provide vision or dental coverage, ends eligibility for premium assistance related to all previously elected COBRA continuation coverage, including previously elected dental-only or vision-only COBRA continuation coverage.

COMPARABLE STATE CONTINUATION COVERAGE – COVERAGE FOR A SUBSET OF STATE RESIDENTS Q-3. Does a State continuation coverage program provide comparable coverage to COBRA continuation coverage for qualifying individuals if the State program covers only a subset of State residents (for example, only employees of a State or local government unit)?

A-3. Yes. A State program does not fail to provide comparable coverage to Federal COBRA continuation coverage solely because the program covers only a subset of State residents, as long as the program provides coverage otherwise comparable to Federal COBRA. For more information on comparable state continuation coverage, see Notice 2021-31, Q&A-61 and Q&A-62. Thus, a State law that provides continuation coverage only for employees of a State or local government unit may be comparable coverage that qualifies Assistance Eligible Individuals for COBRA premium assistance under the ARP.

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CLAIMING THE COBRA PREMIUM ASSISTANCE CREDIT – ADDITIONAL CLARIFICATION ON THE ENTITY THAT MAY CLAIM THE CREDIT Q-4. What is the general rule for determining which entity is the common law employer maintaining the plan, as described in Notice 2021-31, Q&A-72(2)?

A-4. The common law employer maintaining the plan is the current common law employer for Assistance Eligible Individuals whose hours have been reduced or the former common law employer for those individuals who have been involuntarily terminated from employment, which, in both cases, serves as the basis for the individual’s eligibility for COBRA continuation coverage (collectively referred to as the common law employer). Generally, as described in Notice 2021-31, Q&A-72(2), when the requirements in § 6432(b)(2) are satisfied, the common law employer is the entity entitled to claim the credit, subject to the exceptions set forth in Notice 2021-31, Q&A82 (as clarified in Q&A-8 of this notice), and in Q&A-9 and Q&A-10 of this notice.

Q-5. For a period of State-mandated continuation coverage that is comparable to Federal COBRA, if the plan is also subject to Federal COBRA (for example, a period of State-mandated continuation coverage that extends beyond the applicable Federal COBRA period), which entity is the premium payee entitled to claim the COBRA premium assistance credit?

A-5. For State-mandated continuation coverage that is comparable to Federal COBRA and is a group health plan subject to both Federal COBRA and the State mandated continuation coverage, the common law employer is the premium payee entitled to claim the credit because the plan is subject to Federal COBRA. See Notice 2021-31, Q&A-72. Consequently, even if the State-mandated continuation coverage would require the Assistance Eligible Individual to pay the premiums directly to the insurer after the period of

Federal COBRA ends, the insurer is not entitled to claim the COBRA premium assistance credit.

Q-6. If a group health plan (other than a multiemployer plan) subject to Federal COBRA covers employees of different common law employers that are members of a single controlled group, which entity is the premium payee entitled to claim the COBRA premium assistance credit?

A-6. If a plan (other than a multiemployer plan) subject to Federal COBRA covers employees of two or more members of a controlled group, each common law employer that is a member of the controlled group is the premium payee entitled to claim the COBRA premium assistance credit with respect to its employees or former employees. Although all of the members of a controlled group are treated as a single employer for employee benefit purposes, each member is a separate common law employer for employment tax purposes. Therefore, the common law employer is the premium payee, unless Notice 2021-31, Q&A-82 (as clarified in Q&A-8 of this notice) applies, or there is a business reorganization as described in Treas. Reg. § 54.4980B-9 and Q&A-9 of this notice.

Q-7. If a group health plan (other than a multiemployer plan) subject to Federal COBRA covers employees of two or more unrelated employers, which entity is the premium payee entitled to claim the COBRA premium assistance credit?

A-7. If a group health plan (other than a multiemployer plan) subject to Federal COBRA covers employees of two or more unrelated employers, the premium payee entitled to claim the premium assistance credit is the common law employer, unless Notice 2021-31, Q&A-82 (as clarified in Q&A-8 of this notice) applies or there is a business reorganization as described in § 54.4980B-9 and Q&A-9 of this notice.

Q-8. If an entity provides health benefits to employees of another entity, but it is not a third-party payer of those employees’ wages, may it be treated as a third-party

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payer for purposes of applying Notice 2021-31, Q&A-82?

A-8. No. For purposes of Notice 2021-31, Q&A-82, a third-party payer is an entity that pays wages subject to Federal employment taxes and reports those wages and taxes on an aggregate employment tax return that it files on behalf of its client(s). As indicated in Notice 2021-31, Q&A-82, these entities are typically professional employer organizations (PEOs), certified professional employer organizations (CPEOs), or agents described in § 3504.

Example: Employer A and Employer B participate in a Multiple Employer Welfare Arrangement (MEWA) that neither pays wages subject to employment taxes nor reports wages and taxes on an aggregate employment tax return on behalf of Employer A and Employer B. Certain former employees of Employer A and Employer B are Assistance Eligible Individuals eligible for coverage provided by the MEWA. The MEWA is not the premium payee and is therefore not entitled to the COBRA premium assistance credit. Instead, as provided in Notice 2021-31, Q&A-72, and as clarified in Q&A-7 of this notice, Employer A and Employer B are the premium payees and are entitled to the COBRA premium assistance credit.

Q-9. If there is a business reorganization described in § 54.4980B–9, which entity is the premium payee entitled to claim the COBRA premium assistance credit for COBRA continuation coverage elected by Assistance Eligible Individuals who are also M&A qualified beneficiaries (as defined in § 54.4980B–9, Q&A-4) if the selling group (as defined in § 54.4980B–9, Q&A-2 or -3) remains obligated to make COBRA continuation coverage available to the M&A qualified beneficiaries?

A-9. If the selling group remains obligated under § 54.4980B–9, Q&A-8 to make COBRA continuation coverage available to M&A qualified beneficiaries after a business reorganization described in § 54.4980B–9, the entity in the selling group that maintains the group health plan is the premium payee

entitled to claim the COBRA premium assistance credit. If, under § 54.4980B-9, Q&A-8, the common law employer (which may be an entity in the buying group (as defined in § 54.4980B-9, Q&A-2 or -3)) is not obligated to make COBRA continuation coverage available to Assistance Eligible Individuals, the common law employer is not entitled to the COBRA premium assistance credit after the business reorganization.

Q-10. If a group health plan maintained by an agency of a State government (State agency) that provides health coverage to employees of various agencies of the State and local governments within the State is subject to the Federal COBRA requirements under the Public Health Service Act, and Assistance Eligible Individuals would have been required to remit COBRA premiums directly to the State agency were it not for the COBRA premium assistance, which entity is the premium payee entitled to claim the COBRA premium assistance credit?

A-10. If a State agency is obligated to make COBRA continuation coverage available to employees of various agencies of the State and local governments within the State, and the Assistance Eligible Individuals would have been required to remit COBRA premium payments directly to the State agency were it not for the COBRA premium assistance, the State agency is the premium payee entitled to claim the COBRA premium assistance credit. In this case, the common law employer (if other than the State agency) would not be entitled to the COBRA premium assistance credit.

Q-11. If a fully insured plan that is not subject to Federal COBRA is offered by an employer through a Small Business Health Options Program (SHOP), is the employer the premium payee entitled to claim the premium assistance credit?

A-11. Yes, but only in certain circumstances. If a fully insured plan that is not subject to Federal COBRA is offered by an employer through a SHOP exchange, the common law employer is treated as the premium payee and is therefore eligible to claim the premium assistance credit with respect to coverage in the plan if all of the following

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conditions are satisfied: (i) the employer participates in a SHOP exchange that offers multiple insurance choices to employees enrolled in the same small group health plan; (ii) the SHOP exchange provides the participating employer with a single premium invoice, aggregates all premium payments, and then allocates and pays the applicable premium amounts to the insurers; (iii) the participating employer has a contractual obligation with the SHOP exchange to pay all applicable COBRA premiums to the SHOP exchange; and (iv) the participating employer would have received the State mini-COBRA premiums directly from the Assistance Eligible Individuals were it not for the COBRA premium assistance.

If all four of these conditions are satisfied, then the insurer of a plan that is not subject to Federal COBRA is not treated as the premium payee with respect to coverage in the plan and is, therefore, not eligible to claim the credit. However, in all other cases of a fully-insured plan subject solely to State mini-COBRA, the insurer (and not the common law employer) is the premium payee entitled to the premium assistance credit, which is the general rule set forth in Notice 2021-31, Q&A-72.

DRAFTING INFORMATION

The principal authors of this notice are Jason Sandoval and Mikhail Zhidkov of the Office of Associate Chief Counsel (Employee Benefits, Exempt Organizations, and Employment Taxes). Other Treasury Department and IRS officials participated in its development. For further information on the provisions of this notice in general, contact Jason Sandoval at (202) 317-5500 (not a toll-free number). For further information on topics addressed in the section of this notice titled Claiming the COBRA Premium Assistance Credit – Additional Clarification on the Entity that May Claim the Credit, contact Mikhail Zhidkov at (202) 317-4774 (not a toll-free number).

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Source: https://www.irs.gov/newsroom/tax-credits-for-paid-leave-under-the-american-rescue-plan-act-of-2021-for-leave-after-march-31-2021

Note: These FAQs address the tax credits available under the American Rescue Plan Act of 2021 (the "ARP") by employers with fewer than 500 employees and certain governmental employers without regard to the number of employees ("Eligible Employers") for qualified sick and family leave wages ("qualified leave wages") paid with respect to leave taken by employees beginning on April 1, 2021, through September 30, 2021, as well as the equivalent credits available for certain self-employed individuals. For information about the tax credits that may be claimed for qualified leave wages pazid with respect to leave taken by employees prior to April 1, 2021, under the Families First Coronavirus Response Act ("FFCRA") and the COVID-related Tax Relief Act (the "Relief Act"), see Tax Credits for Paid Leave Under the Families First Coronavirus Response Act for Leave Prior to April 1, 2021 FAQs.

Although the requirement that Eligible Employers provide leave under the Emergency Paid Sick Leave Act ("EPSLA") and Emergency Family and Medical Leave Expansion Act ("Expanded FMLA") under the FFCRA does not apply after December 31, 2020, the tax credits under sections 3131 through 3133 of the Internal Revenue Code ("the Code") are available for qualified leave wages an Eligible Employer provides with respect to leave taken by employees beginning on April 1, 2021, through September 30, 2021, if the leave would have satisfied the requirements of the EPSLA and Expanded FMLA, as amended for purposes of the ARP.

Overview Note: These FAQs address the tax credits available under the American Rescue Plan Act of 2021 (the "ARP") by employers with fewer than 500 employees and certain

governmental employers without regard to the number of employees ("Eligible Employers") for qualified sick and family leave wages ("qualified leave wages") paid with respect to leave taken by employees beginning on April 1, 2021, through September 30, 2021, as well as the equivalent credits available for certain self-employed individuals. For information about the tax credits that may be claimed for qualified leave wages paid with respect to leave taken by employees prior to April 1, 2021, under the Families First Coronavirus Response Act ("FFCRA") and the COVID-related Tax Relief Act (the "Relief Act"), see Tax Credits for Paid Leave Under the Families First Coronavirus Response Act for Leave Prior to April 1, 2021 FAQs.

Although the requirement that Eligible Employers provide leave under the Emergency Paid Sick Leave Act ("EPSLA") and Emergency Family and Medical Leave Expansion Act ("Expanded FMLA") under the FFCRA does not apply after December 31, 2020, the tax credits under sections 3131 through 3133 of the Internal Revenue Code ("the Code") are available for qualified leave wages an Eligible Employer provides with respect to leave taken by employees beginning on April 1, 2021, through September 30, 2021, if the leave would have satisfied the requirements of the EPSLA and Expanded FMLA, as amended for purposes of the ARP.

Throughout these FAQs, the use of the word "work," unless otherwise noted, is inclusive of telework.

COVID-19-Related Tax Credits Extended for Paid Leave for Periods Beginning April 1, 2021, through September 30, 2021.

Sections 3131 through 3133 of the Code were enacted by the ARP, on March 11, 2021, to allow Eligible Employers to claim

TAX CREDITS FOR PAID LEAVE UNDER THE AMERICAN RESCUE PLAN ACT OF 2021 FOR LEAVE AFTER MARCH 31, 2021

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refundable tax credits that reimburse them for the cost of providing qualified sick and family leave wages with respect to leave taken by employees beginning on April 1, 2021, through September 30, 2021, either for the employee's own health needs or to care for family members. Employees may receive up to ten days of paid sick leave and up to 12 weeks of paid family leave. Certain self-employed individuals in similar circumstances are entitled to similar credits.

For a more detailed overview of the law, see "Overview of Paid Leave Tax Credits under the ARP," below.

For FAQs, see "General Information FAQs," and the sections that follow. The FAQs will be updated periodically to address changes in the law or additional questions as they are raised.

Overview of Paid Leave Tax Credits under the ARP

The ARP amended and extended the tax credits available to Eligible Employers providing paid sick and family leave consistent with the leave provided under the FFCRA. Under the FFCRA, enacted March 18, 2020, employers were required to provide paid leave through two separate provisions: (1) the EPSLA, under which employees received to up to 80 hours of paid sick time when they were unable to work for certain reasons related to COVID-19, and (2) Expanded FMLA, under which employees received paid family leave to care for a child whose school or place of care was closed or child care provider was unavailable for reasons related to COVID-19. The obligation for employers to provide paid leave under the EPSLA and the Expanded FMLA applied to qualified leave wages paid with respect to leave taken by employees beginning on April 1, 2020, through December 31, 2020. The FFCRA provided that Eligible Employers providing paid leave that satisfied the requirements of the EPSLA and the Expanded FMLA for the periods of time during which employees were unable to work (including telework) were permitted to claim fully refundable tax credits to cover the cost of the paid leave wages. Certain self-employed persons in similar

circumstances were entitled to similar credits. The Relief Act extended the tax credits available to Eligible Employers for paid sick and family leave that would have satisfied the requirements of the EPSLA or Expanded FMLA, as amended for purposes of the Relief Act, for qualified leave wages paid with respect to leave taken by employees through March 31, 2021.

Under the ARP, refundable tax credits are available to Eligible Employers providing paid sick and family leave wages that otherwise would have satisfied the requirements of the EPSLA and Expanded FMLA, as amended for purposes of the ARP, paid with respect to leave taken by employees beginning on April 1, 2021, through September 30, 2021. The ARP codified these credits in sections 3131 through 3133 of the Code. These tax credits are increased by the Eligible Employer's cost of maintaining health insurance coverage allocable to the qualified leave wages ("allocable qualified health plan expenses") and certain amounts paid under collectively bargained agreements by the Eligible Employer that are properly allocable to the qualified leave wages ("certain collectively bargained contributions"). Under section 3133 of the Code, the tax credits are also increased by the employer's share of social security and Medicare taxes imposed on the qualified leave wages.

Under sections 9642 and 9643 of the ARP, self-employed individuals are entitled to equivalent credits based on similar circumstances in which the individual is unable to work. For more information about how self-employed individuals can claim the credits, see "Specific Provisions Related to Self-Employed Individuals".

For leave required under the FFCRA prior to January 1, 2021, the Wage and Hour Division of the Department of Labor (DOL) administers the EPSLA and the Expanded FMLA and issued regulations at 29 CFR Part 826 and posted FAQs and relevant information about the paid leave provisions. See the DOL's Families First Coronavirus Response Act: Questions and Answers.

The following section provides an overview of the ARP's refundable paid leave credit

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provisions, and the FAQs that follow provide more detailed information regarding the requirements, limitations, and application of the paid leave credits.

Overview of Paid Sick Leave Refundable Credit (updated July 29, 2021)

Under the ARP, Eligible Employers are entitled to tax credits if they provide employees with paid sick leave if the employee is unable to work due to any of the following:

1. the employee is under a Federal, State, or local quarantine or isolation order related to COVID-19;

2. the employee has been advised by a health care provider to self-quarantine due to concerns related to COVID-19;

3. the employee is:

l experiencing symptoms of COVID-19 and seeking a medical diagnosis,

l seeking or awaiting the results of a diagnostic test for, or a medical diagnosis of, COVID–19 and the employee has been exposed to COVID–19 or the employee's employer has requested the test or diagnosis, or

l obtaining immunization related to COVID–19 or recovering from any injury, disability, illness, or condition related to the immunization;

4. the employee 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. the employee is caring for the child of the employee if the school or place of care of the child has been closed, or the childcare provider of the child is

unavailable, due to COVID–19 precautions; or

6. the employee is experiencing any other substantially similar condition specified by the Secretary of Health and Human Services (HHS) in consultation with the Secretary of the Treasury and the Secretary of Labor. The Secretary of HHS has specified, after consultation with the Secretaries of Treasury and Labor, that a substantially similar condition is one in which the employee takes leave:

l to accompany an individual to obtain immunization related to COVID-19, or

l to care for an individual who is recovering from any injury, disability, illness, or condition related to the immunization. For more information on who is an “individual” for purposes of this condition, see “Do "qualified sick leave wages" include wages paid for leave taken to accompany an individual who is obtaining a vaccination or to care for an individual who is recovering from vaccination?” and “Do "qualified family leave wages" include wages paid for leave taken to accompany an individual who is obtaining a vaccination or to care for an individual who is recovering from vaccination?”

An Eligible Employer may claim a tax credit for qualified sick leave wages in the following amounts: l For an employee who is unable to work

due to reasons described in (1), (2) or (3) above, the Eligible Employer may claim a tax credit for up to two weeks (up to 80 hours) of paid sick leave 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 leave taken beginning on April 1, 2021, through September 30,

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2021. For more information, see "What is the rate of pay for qualified sick leave wages if an employee is unable to work due to the employee's own health needs and the maximum amount of qualified sick leave wages that may be taken into account?"

l For an employee who is unable to work due to reasons described in (4), (5) or (6) above, the Eligible Employer may claim a tax credit for up to two weeks (up to 80 hours) of paid sick leave at 2/3 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 leave taken beginning on April 1, 2021, through September 30, 2021. For more information, see "What is the rate of pay for qualified sick leave wages if an employee is unable to work because the employee needs to care for others?"

The Eligible Employer is entitled to a fully refundable tax credit for qualified sick leave wages it pays. The Eligible Employer is subject to the employer's share of social security and Medicare taxes imposed on those qualified sick leave wages; however, the tax credit is increased by the amount of the employer's share of social security and Medicare taxes imposed on the qualified sick leave wages, as well as allocable qualified health plan expenses, and certain collectively bargained contributions during the sick leave period.

Overview of Paid Family Leave Refundable Credit

Under the ARP, Eligible Employers are entitled to tax credits if they provide employees with paid family leave because the employee is unable to work due to any of the reasons listed above for which Eligible Employers may provide paid sick leave that would have satisfied the requirements of the EPSLA, as amended for purposes of the ARP. An Eligible Employer may claim a tax credit for qualified family leave wages for an employee who is unable to work due to any of those circumstances, at 2/3 the employee's regular pay, up to $200 per day and $12,000

in the aggregate for qualified family leave wages paid with respect to leave taken by employees beginning on April 1, 2021, through September 30, 2021. Up to 12 weeks of qualifying leave can be counted towards the paid family leave tax credit. An Eligible Employer may not claim the credit for providing paid family leave for any wages for which it claimed a tax credit for providing paid sick leave. For more information, see "What is included in "qualified family leave wages"?"

The Eligible Employer is entitled to a fully refundable tax credit for qualified family leave wages it pays. The Eligible Employer is subject to the employer's share of social security and Medicare taxes imposed on those wages; however, the Eligible Employer's tax credit is increased by the employer's share of social security and Medicare taxes imposed on the qualified sick leave wages, as well as allocable qualified health plan expenses, and certain collectively bargained contributions during the family leave period. For more information, see "How does an Eligible Employer determine the amounts and rate of pay of the qualified family leave wages to pay?"

Claiming the Paid Sick and Family Leave Credits

Under sections 3131 through 3133 of the Code, Eligible Employers are entitled to receive the credits for the full amount of qualified leave wages and certain collectively bargained contributions, plus allocable qualified health plan expenses and the amount of the employer's share of social security and Medicare taxes imposed on the qualified leave wages, that are paid with respect to leave taken by employees beginning on April 1, 2021, through September 30, 2021. The credit is allowed against the taxes imposed on employers by section 3111(b) of the Code (Hospital Insurance (Medicare tax)) and so much of the taxes imposed on employers under section 3221(a) of the Code as are attributable to the rate in effect under section 3111(b) of the Code (the Railroad Retirement Tax Act Tier 1 rate) on all wages and compensation, respectively, paid to all employees. If the amount of the credit

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exceeds the Eligible Employer's share of these federal employment taxes, then the excess is treated as an overpayment and refunded to the Eligible Employer under sections 6402(a) or 6413(b) of the Code. The qualified leave wages are subject to the taxes imposed on employers by sections 3111(a) and 3111(b) of the Code and, for railroad employers, the Railroad Retirement Tax Act Tier 1 rate under section 3221(a) of the Code.

Eligible Employers that pay qualified leave wages may retain an amount of all federal employment taxes equal to the amount of the anticipated tax credits based on qualified leave wages paid (plus allocable qualified health plan expenses, certain collectively bargained contributions, and the employer's share of social security and Medicare taxes imposed on the qualified leave wages), rather than depositing the employment taxes with the IRS. The federal employment taxes that are available for retention by Eligible Employers include federal income taxes withheld from employees, the employees' share of social security and Medicare taxes, and the employer's share of social security and Medicare taxes with respect to all employees.

If the federal employment taxes that are available for retention are not sufficient to cover the Eligible Employer's cost of qualified leave wages (plus allocable qualified health plan expenses, certain collectively bargained contributions, and the employer's share of social security and Medicare taxes imposed on the qualified leave wages), then the Eligible Employer may file a request for an advance payment from the IRS using the applicable version of Form 7200, Advance Payment of Employer Credits Due to COVID-19 for the relevant calendar quarter.

Eligible Employers claiming these credits must retain records and documentation related to and supporting each employee's leave to substantiate the claim for the credits, as well retaining the Forms 941, Employer's Quarterly Federal Tax Return, and 7200, and any other applicable filings made to the IRS requesting the credits.

For more detail on the refundable tax credits and the procedures to receive payment of the advance credit, see "How to Claim the Credits."

For the full guidance please visit https://www.irs.gov/newsroom/tax-credits-for-paid-leave-under-the-american-rescue-plan-act-of-2021-for-leave-after-march-31-2021

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SURRAN: Subsequent to the March 2020 emergency declaration issued by President Trump in response to the coronavirus pandemic, there have been several major disaster relief declarations under the authority of the Stafford Act for each of the 50 states, the District of Columbia and the five U.S. territories.

Initial Notice 2020-46, modified by Notice 2021-42, provided guidance on the federal income and employment tax treatment to employers and their employees of cash payment

made before January 1, 2021, for the relief of victims of COVID-19. Under leave-based donation programs, employees can elect to forgo vacation, sick, or personal leave in exchange for cash payments made by their employer to charitable organizations under Internal Revenue Code section 170(c).

And as the pandemic seems like it’s never ending, the IRS has to plan accordingly and extend most of its tax treatment with respect to COVID-19 and/or provide additional guidance where necessary.

WILLIAMS: It seems that the saga continues with respect to COVID-19’s impact on taxes. Barbara Weltman, president of Big Ideas for Small Business, joins us again this month and starts our conversation with the leave-based donations program and current updates.

WELTMAN: If an employer has a leave-based donation program, employees may contribute their unused leave time, vacation, sick and personal days for the benefit of employees who need the time. Usually employees remain taxed on their donated leave time. However, for 2021, if the employer makes a cash equivalent donation of the leave time to an IRS approved charity before January 1st, 2022, for the benefit of COVID-19 relief, employees aren't taxed on their donations.

They can’t take a charitable contribution deduction, but the donated leave time won't appear on their form W-2. The employer gets the charitable contribution deduction. You may recall this break was put into effect in 2020, following the president's national disaster declaration. Due to the ongoing nature of the pandemic, the break applies through 2021. Will it be extended again? Who knows?

WILLIAMS: Another tax change from the American Rescue Plan Act is COBRA premium assistance. The IRS has provided additional guidance to employers.

WELTMAN: Employers subject to COBRA must provide premium assistance to involuntarily terminated employees, other than those fired for gross misconduct and employees subject to reduced hours. The period of this mandatory assistance is April 1, 2021, through September 30, 2021.

Previously, I told you about some IRS guidance on this, now the IRS provides answers to another 11 specific questions. I'm not going to run through all of them, but you should review them. They address multi-employer plans, state plans, and more. One question concerns the end of COBRA premium assistance period for dental and vision coverage.

Video Transcript

4. IRS Updates

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t Eligibility for COBRA premium assistance ends when an eligible individual becomes eligible for coverage under any other disqualifying group health plan or Medicare, even if the other coverage does not include all of the benefits provided by the previously elected COBRA continuation coverage.

For example, eligibility for Medicare, which generally doesn't provide vision or dental coverage, ends eligibility for premium assistance related to all previously elected COBRA continuation coverage, including previously elected dental only, or vision-only COBRA continuation coverage.

WILLIAMS: What about employers of small businesses who obtained coverage for employees through a small business health options program, SHOP?

WELTMAN: A key question that many have been waiting for an answer concerns a fully insured plan that is not subject to federal COBRA, which is offered by an employer through a small business health options program, a SHOP. The question, whether the employer is the premium payee entitled to claim the premium assistance credit, the IRS says yes, but only in certain circumstances. If a fully insured plan that is not subject to federal COBRA is offered by an employer through a SHOP exchange, the common law employer is treated as the premium payee and is therefore eligible to claim the premium assistance credit with respect to coverage in the plan if four conditions are met.

One; make a lowercase employer participates in a SHOP exchange that offers multiple insurance choices to employees enrolled in the same small group health plan. Down to two; the SHOP exchange provides the participating employer with a single premium invoice, aggregates all premium payments, and then allocates and pays the applicable premium amounts to the insurers. Three; the participating employer has a contractual obligation with the SHOP exchange to pay all applicable COBRA premiums to the SHOP exchange. And four; the participating employer would have received the state mini COBRA premiums directly from the assistance-eligible individuals, were it not for the COBRA premium assistance.

WILLIAMS: The American Rescue Plan extended the voluntary paid sick leave and paid family leave credit through September 30th, 2021. Barbara tells us what is new in this area.

WELTMAN: The IRS updated its FAQs for the paid sick leave and paid family leave through September 30th, 2021. These employment tax credits claimed by employers to make these payments to eligible employees is voluntary now. The new FAQs make it clear that the payments may be made for providing leave to employees, to accompany a family or household member or certain other individuals to obtain immunization related to COVID-19, or to care for a family or household member or certain other individuals recovering from the immunization. And remember, self-employed individuals may claim comparable credits on their form 1040.

WILLIAMS: Barbara discusses yet another pandemic-related change concerning net operating losses (NOLs) for farmers.

WELTMAN: You may remember that the Tax Cuts and Jobs Act ended net operating loss carry-backs for all taxpayers, other than those in farming businesses; they had a two year carry-back. Then due to the pandemic, the CARES ACT created a five-year carry-back for all businesses for NOL arising in 2018, 2019 and 2020.

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t This created considerable confusion for farmers. Well really, for all taxpayers. Now the IRS has provided guidance on when and how to make an election with regard to all NOLs of the taxpayer, regardless of whether the NOL is a farming loss NOL.

A taxpayer is treated as having made a deemed election if the taxpayer, before December 27th, 2020, filed one or more original or amended federal income tax returns or applications for tentative refunds that disregard the CARES ACT amendments with regard to a farming loss NOL.

The IRS has also provided guidance on when and how to revoke an election made to waive the two year carry-back period for farming loss portion of a farming loss NOL incurred in a taxable year, beginning in 2018 or 2019.

WILLIAMS: So why do we need this guidance?

WELTMAN: When it comes to carry-backs, there was, and for farming businesses still is the option of making an irrevocable election to waive a carry-back. Because of this, some farming businesses may have waived the two year carry-back before the five-year carry-back option was available. Bottom line, the IRS had to straighten out all the confusion.

WILLIAMS: Perhaps the biggest part of pandemic assistance has been economic impact payments. Barbara elaborates on the third round of economic impact payments, (EIP-3) sent in 2021.

WELTMAN: The third round of Economic Impact Payments, EIP-3, were sent in 2021. The IRS announced that under the American Rescue Plan Act, it dispersed more than $171 million payments with $2.2 million coming recently, these last payments totaled $4 billion.

I want to remind you that individuals who received payments do not have to report them on 2021 returns filed in 2022. A draft of form 1040 for 2021 shows that the recovery rebate credit may still be claimed by those who did not receive the full amount to which they were entitled. This could occur for example, for someone who had a dependent in 2021, but didn't have the dependent in 2020. Again, if a taxpayer received more than what they should have been paid, there's no repayment required.

SURRAN: We've had a number of cases on various topics with interesting outcomes. Barbara Weltman runs through some of the most important ones, starting with the tax treatment of a malpractice settlement. She reminds us how damages are treated and if there is a way to characterize damages so they can be tax-free.

WELTMAN: Damages from a lawsuit, whether by verdict or settlement are includable in gross income with one exception. Compensatory damages for personal physical injury or sickness are tax-free. So damages for defamation, a non-physical personal injury are taxable, while damages for medical malpractice are tax-free.

In one case, a woman sued her attorney for malpractice related to her divorce. She and her attorney participated in mediation that formed the basis for a property settlement.

Then she received less than one half of the couple's community property. And her attorney said, he'd file for a trial for her claim, but he never did. Then she sued him for malpractice, claiming his representation was negligent. The settlement didn't include her husband's future retirement

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t plan and he failed to press her claims. She sought damages for pecuniary and compensatory losses.

A settlement was reached for $175,000, though no admission of guilt or fault was made by either party. And of her settlement amount, she paid $73,500 to the attorney representing her, netting $101,500. On her 1040, she listed $101,500 as other income, the amount reported on the 1099 MISC., but then she subtracted the same amount from the bottom line. She reported zero income from the settlement.

WILLIAMS: But aren't damages taxable?

WELTMAN: She argued that the proceeds were non-taxable return of capital, because they compensated her for the portion of the marital estate to which she was rightfully entitled but didn't get because of the malpractice. The IRS said the proceeds are taxable because they compensate her for her attorney's failure. The tax court agreed with the IRS. To determine whether a settlement represents lost profit or lost value, the tax court asked and I quote, "In lieu of what was the settlement awarded?" Close quote.

The malpractice settlement terms made it clear that it was in exchange for the release of claims against the attorney for malpractice. It did not relate to the marital property. The court refused to look through the malpractice case to get to the original divorce matters.

WILLIAMS: Barbara discusses a charitable contribution deduction case, where a qualified appraisal may be necessary when property is involved.

WELTMAN: When you're donating property, the deduction usually is based on fair market value on the date of the donation. If the value is over $5,000, a qualified appraisal is required. And if the deductions are over $500,000, then the appraisal must be attached. In one recent case, a deduction was denied because the appraiser didn't meet the standards of being a qualified appraiser.

The taxpayer donated his interest in four oil and gas properties to a church and valued them at $2 million, but he didn't get an appraisal. In the next year, he also donated a conference center to another religious charity and asked a certified general appraiser for help. The appraiser thought it was complicated and he couldn't meet the uniform standards of professional appraisal practice. But nonetheless, he described the three traditional valuation methods and that the replacement cost approach was probably the best here. The problem, there were no comps, so no appraisal. The taxpayer without an appraisal simply claimed a deduction based on his cost. The tax court denied both of his charitable contribution deductions for lack of appraisals as required by the tax code.

WILLIAMS: So is there any way to get a deduction when there's no appraisal?

WELTMAN: There's one escape hatch for well-intentioned taxpayers who fail to comply with appraisal requirements. They may still get a deduction if they can show that the failure is due to reasonable cause and not to willful neglect.

The Tax Court pointed out that neither the code nor the regulations tell us what reasonable cause means here. But in other situations, it requires a taxpayer to exercise ordinary business care and prudence. Unfortunately, for this generous tax payer, he failed to show he exercised ordinary business care and prudence. He didn't provide the necessary information to his return preparers, and he failed to review the returns where he could

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t easily have seen the appraisal requirements stated on form 8283 for non-cash contributions. So not only did he lose sizable charitable contribution deductions, but he was also subject to penalties.

SURRAN: Substantiation is required with all deductions and support for medical expenses is no different. When it comes to medical expenses paid by a debit card tied to a health FSA, proposed regulations dictate substantiation requirements. Substantiation means information describing the product or service, the date of the service or sale and the amount of the expense.

The debit card will obviously show the amount of the expense, but may or may not provide the other required information. If the debit card doesn't show the specific items or services, the FSA plan administrator must request more information from the employee to meet the substantiation requirements. An independent third party must provide the employer with a statement verifying the medical expense either automatically or after the transaction.

If, at the time and point of sale, an independent third party provides information to verify that the charge is for a medical expense, then that expense is substantiated without the need for further review. This substantiation method is known as real-time substantiation.

WILLIAMS: Medical expenses are an expenditure for most individuals. This is so, whether they're paid by insurance, Medicare, Medicaid, FSAs, HSAs, or HRAs. Barbara Weltman continues our discussion on FSAs and the substantiation of recurring payments.

WELTMAN: A payment of recurring expenses for medical expenses, encouraging certain providers that match the amount, medical care provider and time period of previously approved expenses, can be approved without additional substantiation. This substantiation method is known as automatic substantiation.

WILLIAMS: We know that High Deductible Health Plans (HDHPs) are a prerequisite for having a health savings account. Barbara explains how the required minimum deductibles are calculated for the HDHP.

WELTMAN: As you know, for health coverage to be a High Deductible Health Plan, an HDHP, there must be certain minimum payments out of pocket before the insurance kicks in. These amounts vary by self only or family coverage and maybe adjusted annually for inflation. The IRS has clarified what counts toward the minimum annual deductible for an HDHP. For example, if a covered individual is prescribed a drug that costs $1,000, but a discount from the drug manufacturer reduces the cost to the individual to $600, the amount that may be credited towards satisfying the deductible is $600, not $1,000. The same principle also applies to a third party payment, such as a rebate or coupon that has the same effect as a discount.

WILLIAMS: We know that HDHPs can cover certain preventative care without disqualifying the coverage. But how does state law fit into the HDHP?

WELTMAN: An HDHP may provide benefits defined as preventive care without a deductible or with the deductible below the minimum annual deductible. A state statute requiring a plan to provide benefits other than preventive care before the minimum annual deductible is satisfied does not change this outcome.

For example, male contraception and sterilization services are not preventive care for purposes of HDHPs. Therefore, a health plan that provides benefits for these services without a deductible or deductible

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t below the minimum annual deductible for an HDHP, is not an HDHP, even if coverage is required by state statute.

WILLIAMS: Barbara mentioned health FSAs, but we also have dependent care FSAs. We know things have been changing during COVID. What does the IRS have to say about this?

WELTMAN: During the pandemic childcare and summer camp providers have been offering their services online. The question for the IRS is whether these virtual and related daycare services are reimbursable from dependent care FSAs. The IRS didn't directly answer the question.

As we know, expenses for the care of a qualified individual, such as a taxpayer's child up to age 13 may be reimbursable. The age limit was raised to 14 for 2020, and this could affect carry overs of unused FSA money. I would guess the argument could be made that virtual daycare should be treated the same as in-person daycare, because it enables the parent to work. We may hear more about this in the future.

WILLIAMS: We’ve been talking for a while now about the new schedules K-2 and K-3 on partnership and S corporation tax returns. They are now included in the 2021 tax returns for those types of entities. And with any introduction of something new, there is sure to be confusion. Barbara explains.

WELTMAN: The IRS has created separate forms for partnerships and S-corporations that have foreign activities. Until now such activities were reported on line 14 of schedule K-1. For 2021 returns, line 14 of schedule K-1 merely asks if schedule K-3 is attached. So entities with no foreign activities don't have to report anything special on the K-1.

Schedule K-2 is for information about items at the entity level, the S-corporation or the partnership. Schedule K-3 is for the owners’ distributive share of these items. Both draft forms and draft instructions are available now. The IRS has said it would provide penalty relief for K-2s and K-3s for 2021 returns.

So we should obviously try to complete the forms, but clients won't be penalized if we fall a little short of perfection, despite reasonable efforts.

WILLIAMS: There are also draft forms for 2021 returns currently out. Barbara tells us what is available.

WELTMAN: IRS released draft forms of the 1040 and schedules 1, 2 and 3. They're basically the same as the 2020 versions, but there are some differences.

For example, schedule-3 is now two pages and the dependent care credit, which is refundable in 2021, is now in part two of schedule-3 for refundable credits. The lines on form 1040 have been tweaked a little. The charitable contribution deduction for those who don't itemize is not an adjustment to gross income; it's taken just as the QBI deduction, along with the standard deduction amount. Since we use software to prepare returns, it's not essential to know all the lines and schedules, but it's helpful to understand that things are always changing.

WILLIAMS: In the past, Barbara mentioned that the AICPA had asked the IRS to create a form for figuring an S corporation shareholder’s basis in stock and debt. Did that take place?

WELTMAN: The IRS posted in the federal register a solicitation for comments on proposed form 7203, S-corporation shareholders stock and debt basis limitation. Likely the form is in response to the request several years ago by AICPA, that the IRS create the form for basis purposes. The form is not posted with other draft forms, at least not as yet, so you need to

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t request one. The information is in the federal register about the request for comments.

The comments need to be submitted by September 17th, 2021 for consideration. There's no indication about when this form, if adopted, would be effective. Until such time, we have to use the worksheets in the instructions to the schedule K1, a form 1120S to compute the basis limitations for stock and debt.

WILLIAMS: Barbara gives us an update on IRS initiatives to move more things online, such as recognizing e-signatures. Where are we now?

WELTMAN: The IRS launched tax pro accounts. For now, these accounts may be used for submitting a power of attorney and tax authorization request. Tax pro accounts will be expanded to enable other actions by tax professionals on behalf of clients. For example, it's expected that tax pros will be able to correct client information online in real time, no manual processing required. The internal revenue manual has been updated to reflect tax pro accounts.

Tax pros and clients still need to e-sign form 2848 for power of attorney, and form 8821 for tax information authorization. There are set hours that tax pro accounts may be accessed. Tax professionals should use their IRS usernames and passwords to access the tax pro account or create an account after verifying their identities. Tax pros need a centralized authorization file number assigned to them as an individual, as well as the CAF address.

New Pub 5533 explains how to submit authorizations using tax pro accounts and online accounts.

WILLIAMS: Does this mean that individuals may have an online account?

WELTMAN: Individuals may create an online account to view their tax information.

This includes the amount owed, balance details by year, payment history, including any scheduled or pending payments, key information from the most recent return, digital copies of selected notices from the IRS, economic impact payments, if any, and their address.

Individuals may also make payments online, see payment plan options, and request a plan via online payment agreement and access their tax records via get transcript. There's more about why an individual might want to create an online account in new Pub 5533.

WILLIAMS: Barbara gives us an update on upcoming changes for practitioners requiring e-filing and the forms the e-filing rules apply to.

WELTMAN: As practitioners, we're set up to do e-filing for our clients. We've been doing it since the 1980s. You may recall that the Taxpayers First Act changed the e-filing thresholds. It used to be submitting 250 returns or more, then it required e-filing. This dropped to 100 returns in 2021, and in 2022 it's 10 returns. For partnerships, the former 200 threshold in 2018 dropped to 150 in 2019, 100 in 2020 and now it's 50 returns. And tax exempt organizations, all must e-file after July 1st, 2019. What's new is proposed regulations reflecting these new thresholds. If finalized the regulations would apply to returns required to be filed during calendar year 2023. Proposed regulations from May 2018 have been withdrawn.

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t In addition to the usual forms that need to be e-filed like income tax returns, the e-filing requirements apply to a variety of forms, including schedule 1098-C, contributions of motor vehicles, boats, and airplanes, and form 8300, report of cash payments over $10,000 received in a trade or business. Check the proposed regs for a complete list.

WILLIAMS: Each year we get an annual and semi-annual report from the national taxpayer advocate. The semi-annual report was recently released. Barbara gives us an overview, the lessons learned by the IRS and how the IRS responded to the advocate’s recommendations.

WELTMAN: The national taxpayer advocate mid-year report from national taxpayer advocate Erin M. Collins has an assessment of the 2021 filing season.

The conclusion, despite COVID-19 and the IRS's responsibility in distributing economic impact payments, the 2021 filing season wasn't all that different from previous ones, but there was one big difference. At the end of the season, the IRS was still having to manually process 15 million returns, quite a backlog. But when it comes to service for taxpayers, not so good. Remember, most of the IRS staff was still working remotely. Only 76% of telephone callers actually got to speak to someone for assistance.

The semi-annual report suggests that the IRS learned important lessons to help improve tax administration and taxpayer service going forward. The report indicates that this may include the development of accessible, robust online accounts and callback technology. Certainly doable.

The semi-annual report also details how the IRS has responded to previous recommendations by the national taxpayer advocate. The IRS implemented in whole or in part, 66% of the advocates recommendations from the 2020 annual report.

WILLIAMS: One last item to cover is data security and taxes. Barbara Weltman gives us an update and what steps tax professionals can take to boost data security.

WELTMAN: We all know that our business and personal data are vulnerable to hackers. We've seen the headlines about ransomware; we know this is a problem. As tax professionals, we are required to protect client information. The IRS is teaming up with state tax agencies and the tax industry in general, to raise awareness among tax professionals about data security.

You're probably aware of the Security Summit partners; they're in their sixth year now. But despite their efforts, tax-related identity theft continues to climb. This has been exacerbated by the pandemic, with more employees working remotely and more fraudsters using new scams and schemes. As tax professionals, we have to boost our data security. In 2021, there have already been 222 data theft reports by tax professionals, exposing the information of hundreds of their clients.

There are also some recommendations to help you, including using multifactor authentication to protect your tax preparation software accounts. Signing up clients for identity protection pins. Helping clients fight unemployment compensation fraud. Avoiding spear phishing scams, where identity thieves craft personalized emails to entice tax professionals to open a link embedded in the email or open an attachment.

And finally, know the signs of identity theft. Such as suddenly receiving a letter from the IRS requesting confirmation that the service filed a tax return deemed suspicious.

The national tax forms this year featured three webinars focused on cyber and information security, catch them streaming live or recorded.

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Segment Five – Not-for-Profit

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Accounting Updates for NFPs

Segment Overview:

Field of Study:

Recommended Accreditation:

Reading (Optional for Group Study):

Running Time:

Video Transcript:

Course Level:

Course Prerequisites:

Advance Preparation:

Expiration Date:

Accounting (NFP)

November 6, 2022

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

None

1 hour group live 2 hours self-study online

Update

“Topic 842 And Topic 840: Accounting for Lease Concessions Related to the Effects of the Covid-19 Pandemic”

“FASB Accounting Standards Update 2019-06”

See page 5–14.

See page 5–22.

35 minutes

The regulators have been busy providing guidance and not-for-profit accountants have been even busier preparing for the slew of new standards coming out. Kaplan Financial Education discussion leader Allen Fetterman provides an update on where things stand with revenue recognition, leases, CECL, goodwill and intangible assets, gifts in kind, accounting for pandemic-related issues, and other topics impacting not-for-profit organizations

Learning Objectives:

Upon successful completion of this segment, you should be able to: l Identify the issues nonprofit accountants need to be aware of

when dealing with revenue recognition, leases and CECL, l Recognize the options available to nonprofit accountants

when it comes to goodwill and intangible assets, l Describe the disclosure requirements stipulated in ASU

2020-07 Not-for-Profit Entities, and l Recognize the implications of recently issued guidance for

nonprofit accountants related to pandemic issues.

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A. Two-Bucket Approach

i. Bucket One: SEC filers

ii. Bucket Two: All other entities including NFPs

B. Revenue Recognition for Nonprofits

i. Promulgated in 2014

ii. Deferred a couple of times

iii. ASU 2020-05 provided another year of deferral due to COVID

C. Nonprofit Revenue: Examples

i. Contracts with customers

ii. Exchange transactions

iii. Tuition and fees

iv. Sales of goods or services

v. Conference and special events

vi. Advertising, royalties, licensing

D. Guidance for Not-for-Profits on

i. Tuition and housing revenues

ii. Subscriptions and membership dues

iii. Bifurcation between a contribution and an exchange component

iv. Auditing revenue

I. Revenue Recognition Guidance

A. Leases for Nonprofits

i. Issued in 2016

ii. Deferred: ASU 2020-05 l For public nonprofits that have

not issued financial statements as of 6/3/2020

l Deferred to fiscal years beginning after December 15, 2019

l For nonpublic nonprofits: two years later

B.Definition of a Lease

i. A contract that conveys the right to use an asset for a period of time for consideration

C. Identified Asset

i. Explicitly or implicitly stated in the contract

ii. Supplier has no practical ability to substitute

iii. Lessee must have the right to control use during lease term

II. Lease Standard: Background and Provisions

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A. The Leases Standard Requires

i. Lessees recognize a right-of-use asset and a lease liability

ii. Both measured at PV of lease payments

iii. It also includes incremental costs

B. Present Value Rate: What the Standard Requires

i. The rate implicit in the lease if determinable

ii. If not determinable: Use the lessee’s incremental borrowing rate

iii. All nonprofits may elect to use a risk-free rate

C. Leases Standard: Important Provisions

i. Renewal options – conditional

ii. Short-term leases without renewal options reasonably certain to be exercised l Not required to be recognized

iii. Standard applied on a modified retrospective approach l At the beginning of the earliest

year presented l Comparative periods required

“I certainly would recommend the cumulative effect adjustment at the beginning of the year of adoption because there's no need to restate the prior year.”

— Allen Fetterman

D. Accounting for Lease Concessions: Entities

i. Do not have to review contracts

ii. May apply lease modification per

iii. Topics 842 and 840

iv. Should provide disclosures

III. Lease Standard: Other Requirements

IV. Credit Losses Standard and GoodwillA. Credit Losses Standard: Included for

Nonprofits

i. Loans receivable

ii. Programmatic loans receivable

iii. Trade receivables

B. Credit Losses Standard: What’s Scoped Out?

i. Contributions receivable

ii. Grants receivable

C. Fetterman’s Observations on CECL

i. Impairment model changing from incurred loss to an expected loss model

ii. Recognition of loss is being accelerated

iii. Entity must measure all CECL

D. Accounting for Goodwill

i. Amortize over 10 years or less

ii. Straight-line basis

iii. Test for impairment l If a triggering event occurs

iv. No annual test of impairment

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A. ASU 2020-07: Overview

i. Effective fiscal years beginning after 6/15/21

ii. Early adoption permitted

iii. Presentation and disclosure standard

iv. Retrospective application required

v. Will improve transparency

B. Gifts in Kind (GIKs) Include

i. Fixed assets

ii. Use of fixed assets or utilities

iii. Materials or supplies

iv. Intangible assets

v. Donated services

vi. Unconditional promises of those assets

C. ASU 2020-07: Disclosure Requirements

i. Quantitative

ii. Qualitative

D. Qualitative Disclosures

i. Contributed nonfinancial assets: Monetized or utilized

ii. If utilized: Description of program/activities

iv. Nonprofit’s policy about monetizing

v. Description of donor-imposed restrictions

vi. Valuation techniques and inputs used

vii. Principal or most advantageous market used

V. ASU 2020-07

A. ASU 2016-14 Simplified and Improved: How Not-for-Profits

i. Classify net assets

ii. Present information in financial statements and notes

B. Not-for-Profit Organizations Affected

i. Charities

ii. Foundations

iii. Colleges and universities

iv. Health care providers

v. Religious organizations

vi Trade associations

vii. Cultural institutions and others

C. Accounting for Donated Services

i. Prior to ASU 2016-14: Recorded as contribution revenue

ii. Now: Recorded as an equity transfer

D. Potential FASB Nonprofit Entity Projects

i. Consolidation of a Not-for-Profit by a For-Profit Sponsor: removed from agenda

ii. Defining intermediate operating measures

iii. Improving consolidations model

iv. Making targeted improvements to accounting for government grants

v. Providing additional guidance on l Valuation of nonfinancial assets l MD&A

VI. FASB Activity: ASU 2016-14 and Other Projects

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A. Accounting Questions Stemming from the Pandemic

i. Accounting for PPP loans

B. Accounting for PPP Loans: Two Approaches

i. Loan model

ii. Conditional model

C. Nonprofit Accounting for PPP Loans: Following ASC 470

i. At the time of the loan: l Recognize a liability

ii. At the time of forgiveness: l Record a gain on extinguishment

D. Nonprofit Accounting for PPP Loans: NOT Following ASC 470

i. Account for loan as a conditional contribution

ii. At time of loan: l Record refundable advance

iii. Once conditions have been met: l Recognize a contribution

VII. COVID-19: Challenges and Approaches

A. OMB M-21-20 Extensions

i. 6/30/20 YE: Now due 9/30/21

ii. 12/30/20 YE: Now due 3/31/22

iii. 6/30/21 YE: Now due 9/30/22

B. Document Reason for Delayed Filings

i. Offsite working

ii. Staff cutbacks

iii. Sickness

C. Fetterman’s Recommendations

i. Attend CPE sessions

ii. Read the standards

iii. “Keep on trucking”

VIII. Considerations Looking Forward

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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 provides an update on where things stand with revenue recognition, leases, CECL, goodwill and intangible assets, gifts in kind, accounting for pandemic-related issues, and other topics impacting not-for-profit organizations."

l Show Segment 5. The transcript of this video starts on page 5–20 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 to 5–11. Additional objective questions are on pages 5–12 and 5–13.

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

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5. Revenue Recognition, Leases and Other Accounting Updates for NFPs

1. What types of nonprofit revenue falls under the revenue recognition standard and what additional guidance is available to assist nonprofit organizations in the implementation of the standard? What types of revenue recognition implementation issues is your organization dealing with?

2. What are the basic provisions of the lease standard, including the present value rate and other important provisions? How is your organization approaching adoption of the lease standard?

3. How does the CECL standard apply to nonprofits, what is scoped out of the standard, and how does the standard account for credit losses?

4. What option is available to nonprofit entities for goodwill? How will ASU 2019-06 apply to your organization?

5. What are the disclosure requirements of ASU 2020-07?

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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who did it affect, and what provision has been missed by many nonprofits? How has your organization been handling the provisions of ASU 2016-14?

7. What accounting questions and guidance have come about because of the COVID-19 pandemic? How does this guidance affect your organization?

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Discussion Questions (continued)

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Suggested Answers to Discussion Questions5. Revenue Recognition, Leases and Other Accounting

Updates for NFPs1. What types of nonprofit revenue falls

under the revenue recognition standard and what additional guidance is available to assist nonprofit organizations in the implementation of the standard? What types of revenue recognition implementation issues is your organization dealing with? l Nonprofit revenue

b Contracts with customers b Exchange transactions b Tuition and fees b Sales of goods and services b Conference and special events b Advertising, royalties licensing of

intellectual property b Contributions are scoped out of

the standard because a contribution does not constitute a contract with a customer

l Guidance for nonprofits b FASB’s Revenue Recognition

Implementation Q&A b AICPA’s Accounting Guide

Revenue Recognition v Separate chapter devoted to

not-for-profit entities v Includes guidance on tuition

and housing revenues, subscriptions and membership dues, bifurcation between a contribution and an exchange component, and auditing revenue

l Participant response based on personal/organizational experience

2. What are the basic provisions of the lease standard, including the present value rate and other important provisions? How is your organization approaching adoption of the lease standard? l It defines a lease as a contract that

conveys the right to use an asset for a period of time in exchange for consideration

l There must be an identified asset, either explicitly stated or implicitly specified in the contract

l The supplier of the asset has no practical ability to substitute and would not economically benefit from substituting the asset

l The lessee must have the right to control the use of the asset during the lease term

l The standard requires b Entities that lease assets with

lease terms of more than 12 months to recognize a right-of-use asset and a lease liability

b The right-of-use asset and lease liability measured at the present value of the lease payments

b Capitalized costs to include initial direct costs, which are incremental costs that an entity would not have incurred if the lease had not been executed v Broker’s commission v Costs to negotiate the lease,

like legal fees, is not an initial direct cost

l Present value rate b The rate implicit in the lease, but

only if it is readily determinable b If it is not readily determinable,

use the lessee’s incremental borrowing rate

b All nonprofits may elect to use a risk-free rate

l Other important provisions b Renewal options will be included

in the lease term only if the lessee is reasonably certain to exercise the option based on relevant economic factors v Consider the renewal term and

degree of asset customization b Short-term leases with terms of

12 months or less without renewal options that are reasonably certain to be exercised are not required to be recognized on the balance sheet su

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Suggested Answers to Discussion Questions (continued)b The standard will be applied on a

modified retrospective approach v At the beginning of the earliest

year presented v Comparative periods required

b There is an election to apply the standard using a cumulative effect adjustment to net assets at the beginning of the year of adoption v No need to restate the prior

year l Participant response based on

personal/organizational experience

3. How does the CECL standard apply to nonprofits, what is scoped out of the standard, and how does the standard account for credit losses? l Credit losses standard applicable to

nonprofits b Loans receivable b Programmatic loans receivable b Trade receivables

l Scoped out of the standard b Contributions receivable b Grants receivable

l Accounting for credit losses b The impairment model is

changing from an incurred loss model to an expected loss model

b The recognition of the loss is being accelerated

b It requires an entity to measure all Current Expected Credit Losses (CECL) v Requires an entity to measure

CECL over the contractual life of a financial asset

v Current conditions and broader range of reasonable and supportable information is now used to make credit loss estimates

v An organization records the difference between the amortized cost and the amount to be collected as an allowance for credit losses

4. What option is available to nonprofit entities for goodwill? How will ASU 2019-06 apply to your organization? l ASU 2019-06 extended an option to

the nonprofit sector that was previously only available to private companies

l Nonprofit entities that have goodwill on their books can b Amortize the goodwill over 10

years or less, if appropriate v On a straight-line basis

b Test for impairment only when a triggering event occurs that indicates that the fair value of the entity may be below its carrying amount v No annual test for impairment

l Participant response based on personal/organizational experience

5. What are the disclosure requirements of ASU 2020-07? l Quantitative

b Contributed non-financial assets recognized on the Statement of Activities disaggregated by category

b Depicts the type of contributed non-financial assets, services, pharmaceuticals, building, equipment, each in a separate type of category

b Quantitatively disclose the amount for each of these categories

l Qualitative disclosures b For each category, information

about whether the contributed nonfinancial assets were either monetized or utilized

b If utilized, a description of the programs or other activities in which those assets were used

b The nonprofit’s policy about monetizing, rather than utilizing the contributed non-financial assets

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Suggested Answers to Discussion Questions (continued)

b The description of any donor-imposed restrictions associated with the contributed non-financial assets

b The valuation techniques and inputs used to arrive at a fair value measure at initial recognition

b The principal market or most advantageous market used to arrive at a fair value measure

6. What was the purpose of ASU 2016-14, who did it affect, and what provision has been missed by many nonprofits? How has your organization been handling the provisions of ASU 2016-14? l ASU 2016-14 simplified and

improved b How not-for-profit entities

classify net assets b Information presented in financial

statements and notes about liquidity, financial performance, and cash flows

l ASU 2016-14 affected not-for-profit organizations and the users of their general purpose financial statements b Charities b Foundations b Colleges and universities b Health care providers b Religious organizations b Trade associations b Cultural institutions and others

l ASU 2016-14 missed provision b Prior to ASU 2016-14, services

donated from an affiliate were recorded as contribution revenue

b Under ASU 2016-14, the credit should be reported as an equity transfer

b Equity transfers should be reported separately as a change in net assets after a subtotal v Such as a change in net assets

before equity transfers l Participant response based on

personal/organizational experience

7. What accounting questions and guidance have come about because of the COVID-19 pandemic? How does this guidance affect your organization? l Accounting for PPP loans

b AICPA issued a technical Q&A 3200.18

b Two approaches to account for loans under the PPP program

b Loan model v May account for the loan as a

financial liability in accordance with ASC 470

v Debt and accrued interest on the liability

v If and when the loan is forgiven, the nonprofit would record a gain on extinguishment

b Conditional contribution model v The nonprofit expects to meet

the PPP’s eligibility criteria for loan forgiveness, and concludes that the loan represents in substance a grant

v Account for the loan under ASC 958-605, as a conditional contribution

v The cash inflow is treated as a refundable advance

v A contribution is recognized once the conditions of the release have been substantially met or explicitly waived

l Extension of due dates on single audit reports b A 3-month audit submission

extension for single audits of 2020 year-ends through September 30, 2020 year-ends v Only if the recipient expended

COVID-19 funding on the SEFA

b OMB M-21-20 provides single audit due date extensions to recipients and subrecipients that have not yet filed with the Federal Audit Clearinghouse as of March 19, 2021

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Suggested Answers to Discussion Questions (continued)

v Covers organizations that have a fiscal year-end through June 30, 2021

v Extends through six months beyond the normal due date

v Applies to all entities who are required to undergo a single audit, not just those that have COVID-19 funding

l AICPA Government Audit Quality Center b Issued nonauthoritative guidance

on the reporting of certain COVID-19 awards on an accrual basis SEFA

b Provides illustrative scenarios to assist in determining which fiscal year to report costs incurred

b Updates its summary of uniform guidance applicability for new COVID-19 related federal programs

l Participant response based on personal/organizational experience

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1. The AICPA Accounting Guide entitled Revenue Recognition:

a) is updated annually

b) does NOT provide information on auditing revenue

c) has a separate chapter devoted to not-for-profit entities

d) does NOT provide guidance for nonprofits

2. The lease standard requires an entity to recognize a right-of-use asset when the lease term is:

a) month-to-month

b) at least 6 months

c) renewable

d) more than 12 months

3. Under ASU 2019-06, goodwill is amortized on a straight-line basis over a period of:

a) 5 years

b) 10 years or less

c) 15 years

d) 20 years or less

4. Which of the following is true regarding the disclosure requirements of ASU 2020-07?

a) it requires quantitative and qualitative disclosure of contributed nonfinancial assets

b) prospective application is required

c) early adoption of the disclosures is NOT permitted

d) the requirements are effective for fiscal years beginning after June 15, 2022

5. When a nonprofit receives services donated from an affiliate, the credit is recorded as:

a) contributed revenue

b) an equity transfer

c) a liability

d) a contra asset

6. The OMB memorandum M-21-20, extended the due date of single audits through:

a) 1 month beyond the normal due date

b) 3 months beyond the normal due date

c) 6 months beyond the normal due date

d) 9 months beyond the normal due date

7. Accounting for lease concessions related to the effects of the COVID-19 pandemic requires:

a) analyzing each contract to determine whether enforceable rights and obligations for concessions exist in the contract

b) accounting for all lease concessions as if the enforceable rights and obligations existed in the original contract

c) accounting for all lease concessions in accordance with the lease modification guidance in Topic 842 and Topic 840

d) providing disclosures about lease concessions related to the effects of the COVID-19 pandemic

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 5–14.

5. Revenue Recognition, Leases and Other Accounting Updates for NFPs

Objective Questions

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8. ASU 2019-06:

a) is expected to increase the cost of the subsequent accounting for goodwill

b) applies to only certain not-for-profit entities

c) reduces the complexity associated with the subsequent accounting for goodwill

d) applies to for-profit entities

9. A not-for-profit entity that elects to apply the accounting alternative on Topic 350 is required to test for goodwill impairment:

a) when a triggering event indicates that the entity’s fair value is below its carrying amount

b) annually

c) every 10 years

d) when the fair value of the entity changes

10. If elected, the accounting alternative in Topic 350 is applied:

a) retroactively

b) prospectively

c) as an accounting error

d) as a change in accounting policy

Objective Questions (continued)

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Self-Study Option

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TOPIC 842 AND TOPIC 840: ACCOUNTING FOR LEASE CONCESSIONS RELATED TO THE EFFECTS OF THE COVID-19 PANDEMIC

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

Source: https://www.fasb.org/cs/Satellite?cid=1176174459740&pagename=FASB%2FFASBContent_C%2FGeneralContentDisplay

PURPOSE OF THIS STAFF Q&A

This FASB staff question-and-answer document (Q&A) focuses on the application of the lease guidance in Topic 842, Leases, and Topic 840, Leases (if Topic 842 has not yet been adopted) for lease concessions related to the effects of the Coronavirus Disease 2019 (also referred to as COVID-19 pandemic).

The FASB staff has been informed that because of the business disruptions and challenges severely affecting the global economy caused by the COVID-19 pandemic, many lessors are, or will be, providing lease concessions to lessees for a significant number of lease contracts. Stakeholders have noted that while the concessions could vary in form, payment forgiveness and deferral of payments are expected to be the most common types of concessions granted. Additionally, stakeholders have highlighted that because of

the severity of the COVID-19 pandemic on the global economy, the number of contracts for which concessions are granted is expected to be substantial for many lessors and lessees.

As part of the Board’s continuing commitment to educate stakeholders and to provide interpretive guidance on accounting for lease concessions during a global economic crisis resulting from an unprecedented pandemic, the FASB staff has developed this Q&A to respond to some frequently asked questions about accounting for lease concessions related to the effects of the COVID-19 pandemic. The interpretation provided herein is applicable to entities whose leases are affected by the economic disruptions caused by the COVID-19 pandemic.

The FASB staff developed this Q&A based on the information and feedback received from various stakeholders through the date on which this Q&A has been issued. The FASB staff will continue to monitor this unique and evolving situation and communicate with the industry as this situation unfolds, including through additional statements, technical inquiries, and other means, as appropriate. The FASB staff

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plans to host a leases roundtable later this year to discuss lease implementation issues, including certain aspects of the lease modification accounting model in Topic 842, that may cause ongoing challenges for all stakeholders and how those issues potentially could be addressed before private companies and not-for-profit organizations are required to adopt the leases standard.

BACKGROUND Subsequent changes to lease payments that are not stipulated in the original lease contract are generally accounted for as lease modifications under Topic 842 or Topic 840. Some contracts may contain explicit or implicit enforceable rights and obligations that require lease concessions if certain circumstances arise that are beyond the control of the parties to the contract. If a lease contract provides enforceable rights and obligations for concessions in the contract and no changes are made to that contract, the concessions are not accounted under the lease modification guidance in Topic 842 or Topic 840. If concessions granted by lessors are beyond the enforceable rights and obligations in the contract, entities would generally account for those concessions in accordance with the lease modification guidance in Topic 842 or Topic 840.

To provide clarity in response to the crisis, the FASB staff has provided the following interpretation as an acceptable approach in accounting for lease concessions related to the effects of the COVID-19 pandemic.

QUESTIONS AND ANSWERS—GENERAL QUESTIONS ABOUT ACCOUNTING FOR LEASE CONCESSIONS RELATED TO THE EFFECTS OF THE COVID-19 PANDEMIC

Question 1

Are lease concessions related to the effects of the COVID-19 pandemic required to be accounted for in accordance with the lease

modification guidance in Topic 842 and Topic 840?

Response

The FASB staff has been made aware that, given the unprecedented and global nature of the COVID-19 pandemic, it may be exceedingly challenging for entities to determine whether existing contracts provide enforceable rights and obligations for lease concessions and, if so, whether those concessions are consistent with the terms of the contract or are modifications to a contract. That analysis could become even more complex considering the programs being implemented or encouraged by governments that permit or require forbearance, such as temporary suspension of an entity’s responsibility to perform on its contractual obligations (that is, lessor’s obligation to make the leased asset available for use to the lessee and lessee’s obligation to make payment) during the period affected by the effects of the COVID-19 pandemic. Furthermore, in anticipation of the large volume of lease contracts for which concessions related to the effects of the COVID-19 pandemic likely will be granted, the FASB staff understands that, absent interpretive guidance, applying the lease modification requirements in Topic 842 (or Topic 840) to each contract for which concessions related to the effects of the COVID-19 pandemic are made could be costly and complex for both lessees and lessors.

While the lease modification guidance in Topic 842 and Topic 840 addresses routine changes to lease terms resulting from negotiations between the lessee and the lessor, the FASB staff believes that this guidance did not contemplate concessions being so rapidly executed as a result of a major financial crisis arising from the COVID-19 pandemic. The FASB staff notes that the underlying premise in requiring a modified lease to be accounted for as if it were a new lease under Topic 842 is that the modified terms and conditions affect the economics of the lease for the remainder of the lease term. The FASB staff is aware that another view is that recognition of lease concessions related to the effects of the COVID-19 pandemic over the remainder of

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lease term (as required under modification accounting) may not reflect the economics of those concessions.

To provide clarity in response to the crisis, the FASB staff believes that it would be acceptable for entities to make an election to account for lease concessions related to the effects of the COVID-19 pandemic consistent with how those concessions would be accounted for under Topic 842 and Topic 840 as though enforceable rights and obligations for those concessions existed (regardless of whether those enforceable rights and obligations for the concessions explicitly exist in the contract). Consequently, for concessions related to the effects of the COVID-19 pandemic, an entity will not have to analyze each contract to determine whether enforceable rights and obligations for concessions exist in the contract and can elect to apply or not apply the lease modification guidance in Topic 842 and Topic 840 to those contracts.

This election is available for concessions related to the effects of the COVID-19 pandemic that do not result in a substantial increase in the rights of the lessor or the obligations of the lessee. For example, this election is available for concessions that result in the total payments required by the modified contract being substantially the same as or less than total payments required by the original contract. The FASB staff expects that reasonable judgment will be exercised in making those determinations.

Some concessions will provide a deferral of payments with no substantive changes to the consideration in the original contract. A deferral affects the timing, but the amount of the consideration is substantially the same as that required by the original contract. The staff expects that there will be multiple ways to account for those deferrals, none of which the staff believes are more preferable than the others. Two of those methods are:

1. Account for the concessions as if no changes to the lease contract were made. Under that accounting, a lessor would increase its lease receivable, and a lessee would increase its accounts payable as receivables/payments accrue.

In its income statement, a lessor would continue to recognize income, and a lessee would continue to recognize expense during the deferral period.

2. Account for the deferred payments as variable lease payments.

Question 2

Is an entity precluded from accounting for lease concessions related to the effects of the COVID-19 pandemic by applying the lease modification guidance in Topic 842 and Topic 840?

Response

No. An entity may account for lease concessions related to the effects of the COVID-19 pandemic in accordance with the lease modification accounting guidance in Topic 842 and Topic 840.

Question 3

Does an entity have to account for all lease concessions related to the effects of the COVID-19 pandemic either (a) as if the enforceable rights and obligations to those concessions existed in the original contract or (b) in accordance with the lease modification guidance in Topic 842 and Topic 840?

Response

No. However, in accordance with paragraph 842-10-10-1, entities should apply Topic 842 consistently to leases with similar characteristics and in similar circumstances. Therefore, entities should apply reasonable judgment in applying that paragraph to lease concessions related to the effects of the COVID-19 pandemic.

Question 4

Should an entity provide disclosures about lease concessions related to the effects of the COVID-19 pandemic?

Response

Yes. Based on existing disclosure requirements in GAAP, an entity should

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provide disclosures about material concessions granted (lessors) or received (lessees) and the accounting effects to enable users to understand the nature and financial effect of the lease concessions related to the effects of the COVID-19 pandemic.

Printable pdf available on https://www.fasb.org/cs/Satellite?cid=1176174459740&pagename=FASB%2FFASBContent_C%2FGeneralContentDisplay

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FASB ACCOUNTING STANDARDS UPDATE

No. 2019-06 May 2019

Intangibles—Goodwill and Other (Topic 350),

Business Combinations (Topic 805), and Not-for-Profit Entities (Topic 958)

Extending the Private Company Accounting

Alternatives on Goodwill and Certain Identifiable

Intangible Assets to Not-for-Profit Entities

An Amendment of the FASB Accounting Standards Codification®

Financial Accounting Standards Board

Accounting Standards Update 2019-06

Intangibles—Goodwill and Other (Topic 350), Business Combinations (Topic 805), and Not-for-Profit Entities (Topic 958)

Extending the Private Company Accounting Alternatives on Goodwill and Certain Identifiable Intangible Assets to Not-for-Profit Entities May 2019 CONTENTS Page Numbers

Summary .............................................. 1–4 Amendments to the FASB Accounting Standards Codification® .................... 5–29 Background Information and Basis for Conclusions ...................................... 30–39 Amendments to the XBRL Taxonomy ................................................................. 40

Summary ___________________________________

Why Is the FASB Issuing This Accounting Standards Update (Update)?

In 2014, the Board issued Accounting Standards Update No. 2014-02, Intangibles—Goodwill and Other (Topic 350): Accounting for Goodwill, and Accounting Standards Update No. 2014-18, Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination (consensuses of the Private Company Council [PCC]), which simplify the subsequent accounting for goodwill and the accounting for certain identifiable intangible assets in a business combination. Those

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amendments were in response to concerns expressed by private companies and their stakeholders (including users) about the cost and complexity of the goodwill impairment test and the accounting for certain identifiable intangible assets, among other concerns. When the Board issued both Updates, it acknowledged that the issues the Updates addressed were not limited to private companies; they also pertain to not-for-profit entities and public business entities. Therefore, the Board added to its agenda projects addressing the subsequent accounting for goodwill and the accounting for certain identifiable intangible assets for those other entity types.

The Board received feedback from not-for-profit stakeholders that questioned the relevance of an impairment-only approach to goodwill as well as input that the benefits of the current accounting for goodwill and identifiable intangible assets acquired in an acquisition by a not-for-profit entity do not justify the related costs. By providing accounting alternatives, the amendments in this Update will reduce for preparers the cost and complexity associated with the subsequent accounting for goodwill and the measurement of certain identifiable intangible assets acquired without significantly diminishing decision-useful information for users of not-forprofit financial statements. The objective of the amendments is to extend the scope of the accounting alternatives provided in Updates 2014-02 and 2014-18 to notfor-profit entities, not to amend the guidance in the alternatives. The Board has another project on its agenda to examine the subsequent accounting for goodwill and the accounting for identifiable intangible assets, the scope of which will be determined after receiving feedback through an Invitation to Comment. The Board could decide that any amendments developed as part of that project also should apply to entities within the scope of this Update. Thus, it is possible that entities electing these alternatives could be subject to future changes to the subsequent accounting for goodwill as a result of that project.

Who Is Affected by the Amendments in This Update?

The amendments in this Update apply to all not-for-profit entities as defined in the Master Glossary of the Codification, including those that are conduit bond obligors.

A not-for-profit entity within the scope of the amendments in this Update that elects to apply the accounting alternative in Topic 350, Intangibles—Goodwill and Other, would be subject to all of the related subsequent measurement, derecognition, other presentation matters, and disclosure requirements of the accounting alternative. A not-for-profit entity within the scope of the amendments that elects to apply the accounting alternative in Topic 805, Business Combinations, is subject to all of the recognition requirements of the accounting alternative. A not-for-profit entity should apply the accounting alternative in Topic 805, if elected, to all transactions within the scope, defined below, that are entered into after the effective date.

The amendments in this Update related to the accounting alternative in Topic 805 apply when a not-for-profit entity within the scope is required to recognize or otherwise consider the fair value of intangible assets as a result of any one of the following transactions (in-scope transactions):

1. Applying the acquisition method under Topic 805 (or Subtopic 958-805, Not-for-Profit Entities—Business Combinations)

2. Assessing the nature of the difference between the carrying amount of an investment and the amount of underlying equity in net assets of an investee when applying the equity method under Topic 323, Investments—Equity Method and Joint Ventures

3. Adopting fresh-start reporting under Topic 852, Reorganizations.

What Are the Main Provisions?

The amendments in this Update extend the private company alternatives from Topic

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350 (Update 2014-02) and Topic 805 (Update 2014-18) to not-for-profit entities.

Under the amendments to the accounting alternative in Topic 350, a not-for-profit entity should amortize goodwill on a straight-line basis over 10 years, or less than 10 years if the not-for-profit entity demonstrates that a shorter useful life is more appropriate. A not-for-profit entity that elects this accounting alternative is required to make an accounting policy election to test goodwill for impairment at either the entity level or the reporting unit level. A not-for-profit entity is required to test goodwill for impairment when a triggering event occurs that indicates that the fair value of the entity (or a reporting unit) may be below its carrying amount. Under the amendments to the accounting alternative in Topic 805, for transactions occurring after adoption of the alternative, a not-for-profit entity should subsume into goodwill and amortize customer-related intangible assets that are not capable of being sold or licensed independently from the other assets of a business and all noncompetition agreements acquired.

A not-for-profit entity that elects the accounting alternative in Topic 805 is required to adopt the alternative in Topic 350 to amortize goodwill. However, a not-for-profit entity that elects the accounting alternative in Topic 350 is not required to adopt the accounting alternative in Topic 805.

How Do the Main Provisions Differ from Current Generally Accepted Accounting Principles (GAAP) and Why Are They an Improvement?

Under the amendments to Topic 350 in this Update, instead of testing goodwill for impairment annually at the reporting unit level, a not-for-profit entity that elects the accounting alternative should amortize goodwill on a straight-line basis, test for impairment upon a triggering event, and have the option to elect to test for impairment at the entity level.

Under the amendments to Topic 805 in this Update, a not-for-profit entity that elects the accounting alternative should recognize fewer items as separate intangible assets in

an acquisition. At present, an acquirer recognizes most assets acquired and liabilities assumed in an acquisition by a not-for-profit entity at their acquisition date fair values, including identifiable intangible assets. An intangible asset is identifiable if it meets either of the following criteria:

1. It arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.

2. It is separable, that is, capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability, regardless of whether an entity intends to do so.

The amendments to the accounting alternatives in Topics 350 and 805, if elected, will reduce for preparers the cost and complexity associated with the subsequent accounting for goodwill and the accounting for certain items that currently are considered to be identifiable intangible assets for not-for-profit entities without significantly reducing relevance to users of not-for-profit financial statements.

Additionally, the amendments make minor technical corrections to Section 350-20- 40, Intangibles—Goodwill and Other—Goodwill—Derecognition, updating guidance originally amended by FASB Statement No. 164, Not-for-Profit Entities: Mergers and Acquisitions.

When Will the Amendments Be Effective?

The amendments are effective upon issuance of this Update. Consistent with the existing private company alternatives for goodwill and certain intangible assets, not-for-profit entities electing to adopt these alternatives do not have to demonstrate preferability and should follow the transition guidance the first time they elect to adopt the alternatives. Not-for-profit entities have the same openended effective date and unconditional one-time election that private companies have.

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The transition methods for the guidance on each accounting alternative are the same for not-for-profit entities as the previous transition methods for private companies. A not-for-profit entity should apply the accounting alternative in Topic 350, if elected, prospectively for all existing goodwill and for all new goodwill generated in acquisitions by not-for-profit entities. A not-for-profit entity should apply the accounting alternative in Topic 805, if elected, prospectively upon the occurrence of the first transaction within the scope of the alternative.

______________________________

Amendments to the FASB Accounting Standards Codification®

_______________________________

Summary of Amendments to the Accounting Standards Codification

1. The following table provides a summary of the amendments to the Accounting Standards Codification.

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Codification Section Description of Changes

Scope and Scope Exceptions (350-20-15) (805-20-15)

l Amended the guidance to extend the scope of the accounting alterna-tive to not-for-profit entities and updated paragraph references in Subtopics 350-20, Intangibles—Goodwill and Other—Goodwill, and 805-20, Business Combinations—Identifiable Assets and Liabilities, and Any Noncontrolling Interest.

Recognition (805-20-25) (958-805-25)l

l Amended the guidance in Subtopic 805-20 to expand the reference to the accounting alternative. l Amended the guidance in Subtopic 958-805, Not-for-Profit Entities—Business Combinations, to add a reference to the accounting alternative

Subsequent Measurement (958-805-35)

l Added to Subtopic 958-805 a reference to the accounting alternative.

Subsequent Measurement (323-10-35) (350-20-35) Derecognition

l Added conforming amendments to incorporate language for not-for-profit entities in Subtopics 323-10, Investments—Equity Method and Joint Ventures—Overall, 350-20, 805-30, Business Combinations—Goodwill or Gain from Bargain Purchase, Including Consideration Transferred, and 958-805.

(350-20-40) Other Presentation Matters (350-20-45) Disclosure (350-20-50) (805-30-50) (958-805-50) Transition and Open Effective Date Information (350-20-65) (805-20-65)

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Introduction

2. The Accounting Standards Codification is amended as described in paragraphs 3–20. In some cases, to put the change in context, not only are the amended paragraphs shown but also the preceding and following paragraphs. Terms from the Master Glossary are in bold type. Added text is underlined, and deleted text is struck out.

Amendments to Subtopic 350-20

3. Amend paragraphs 350-20-15-3A through 15-4, with no link to a transition paragraph, as follows:

Intangibles—Goodwill and Other—Goodwill

Overview and Background

General

350-20-05-1 This Subtopic addresses financial accounting and reporting for goodwill subsequent to its acquisition and for the cost of internally developing goodwill.

350-20-05-2 Subtopic 805-30 provides guidance on recognition and initial measurement of goodwill acquired in a business combination. Subtopic 958-805 provides guidance on recognition and initial measurement of goodwill acquired in an acquisition by a not-for-profit entity.

350-20-05-3 Paragraph superseded by Accounting Standards Update No. 2017- 04.

350-20-05-4 The guidance in this Subtopic is presented in the following two Subsections:

a. General

b. Accounting Alternative.

350-20-05-4A Costs of developing, maintaining, or restoring internally generated goodwill should not be capitalized. For entities that do not elect the accounting

alternative included in the guidance in the Subsections outlined in paragraph

350- 20-05-5A, goodwill that is recognized under the business combination guidance in Topic 805 and Subtopic 958-805 should not be amortized. Instead, it should be tested for impairment at least annually in accordance with paragraphs 350-20-35- 28 through 35-32.

350-20-05-4B This Subtopic also includes guidance on the following:

a. How an entity should derecognize goodwill when it disposes of all or a portion of a reporting unit

b. How goodwill should be presented in the balance sheet

c. How impairment losses should be presented in the income statement

d. What disclosures about goodwill and related impairment considerations should be made in the notes to the financial statements.

For the full ASU 2019-06 update see https://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176172752478&acceptedDisclaimer=true

Copyright © 2019 by Financial Accounting Foundation. All rights reserved. Content copyrighted by Financial Accounting Foundation may not be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the Financial Accounting Foundation. Financial Accounting Foundation claims no copyright in any portion hereof that constitutes a work of the United States Government.

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SURRAN: In 2019, the FASB adopted a two-bucket approach to stagger effective dates for major standards. Bucket One is for SEC filers, excluding smaller reporting companies as defined by the SEC. Bucket Two applies to all other entities including all not-for-profit organizations and that also means not-for-profit entities that have issued, or are conduit bond obligors for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market.

What this philosophy said is that the effective dates for major standards for Bucket Two entities, which include all nonprofits, will be at least two years after the effective dates for Bucket One entities. This will give nonprofits the time to learn from SEC filers who are required to implement the standards sooner.

WILLIAMS: Two major standards that not-for-profit entities have been dealing with for a long time are revenue recognition and leases. Helping us to understand where things stand with not-for-profit organizations implementing these standards 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 begins by discussing revenue recognition and when the standard becomes effective for not-for-profit organizations.

FETTERMAN: Well, revenue recognition has been around for a while. It was actually promulgated back in 2014, and it's been deferred a couple of times. The latest one was ASU 2020-05, which provided an additional one year of deferral because of the Coronavirus pandemic.

What it says is for nonpublic entities that have not yet issued their 2019 financial statements as of June 30, 2020, when this ASU came out, the effective date now for revenue recognition will be years beginning after December 15, 2019, which means fiscal years ending December 31st, 2020, which is past us already and June 30, 2021 and September 30, 2021 year-ends, which are in the process of closing and having audits started.

WILLIAMS: Allen describes the types of revenue that fall under the new standard.

FETTERMAN: Nonprofit organizations receive a lot of types of revenue. The standard applies to nonprofits as much as it applies to for-profit entities.

For example, nonprofits receive revenue from contracts with customers, exchange transactions, tuition, fees, sales of goods, sales of services, conference and special events revenues, revenue from advertising, royalties, licensing of intellectual property.

What I think everyone should understand is that contributions are scoped out of the standard because a contribution doesn't constitute a contract with a customer. A donor is not a customer. It includes pretty much all forms of revenue that a nonprofit gets with the exception of contributions.

WILLIAMS: Next Allen tells us what additional guidance is available to assist organizations in the implementation of the revenue recognition standard.

Video Transcript

5. Revenue Recognition, Leases and Other Accounting Updates for NFPs

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t FETTERMAN: The Financial Accounting Standards Board published a Revenue Recognition Implementation Q&A, which provides information on the implementation of the Rev Rec standard.

In addition, the American Institute of CPAs publishes an Audit and Accounting Guide entitled Revenue Recognition. This guide does not come out annually, as many other A&A guides do, but it's updated periodically.

The latest update was in 2021. There's a separate chapter in this guide devoted to not-for-profit entities, which includes guidance on things such as tuition and housing revenues,

subscriptions and membership dues, bifurcation of transactions between a contribution and an exchange component. It provides a lot of information. It also provides information on auditing revenue with this new standard.

WILLIAMS: The other major standard nonprofit accountants have been focused on is leases. Allen Fetterman tells us when the lease standard becomes effective for not-for-profit organizations.

FETTERMAN: The lease standard has also been around for years. It was initially issued back in 2016. It's in Topic 842 of the codification. Again, because of the pandemic, the latest deferral was ASU 2020-05. It provided the one-year deferral.

Just like we discussed with Rev Rec, for public nonprofits that have not yet issued financial statements as of June 3, 2020, the date that ASU 2020-05 was issued, it's been deferred to years beginning after December 15, 2019, which would be calendar year 2020, fiscal years ending in 2021, June 30, 2021, September, 30, 2021.

For nonpublic nonprofits, the overwhelming majority of nonprofits are nonpublic because they don't issue public debt and they're not conduit debt obligers, it's two years later.

Remember the two-year philosophy we talked about before? It will be years beginning after December 15, 2021, which would mean calendar year 2022, fiscal years ending in 2023. Now, of course, early adoption is permitted.

WILLIAMS: What are the basic provisions of the standard? Allen explains.

FETTERMAN: The standard basically first defines a lease. It says that a lease is a contract that conveys the right to use an asset for a period of time in exchange for consideration. You should understand that there must be an identified asset. An identified asset means it's either explicitly stated or implicitly specified in the contract and that the supplier of the asset has no practical ability to substitute and would not economically benefit from substituting the asset. In addition, and this is really important, the lessee must have the right to control the use of the asset during the lease term.

What that simply means is that the lessee has decision-making authority over the use of the asset and the ability to obtain substantially all the economic benefits from the use of the asset.

The standard requires that entities that lease assets, lessees, with lease terms of more than 12 months to recognize a right-of-use asset and a lease liability, both of them measured at the present value of the lease payments included in the capital lease costs because it's going on the balance sheet. All leases go on the balance sheet.

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t It will include initial direct costs, that is incremental costs that an entity would not have incurred if the lease had not been executed.

A classic example is the broker's commission. If an organization pays a brokerage commission as part of obtaining and negotiating the lease, that would be included in the capitalized cost. However, the actual cost to negotiate the lease like legal fees, that would not be because that's not considered an initial direct cost.

WILLIAMS: Earlier, Allen mentioned present value. But does the standard require a specific discount rate?

FETTERMAN: Well, we're going to discount the lease amount back to present value using some rate. The standard does address what rate to use. It requires the rate implicit in the lease but only if that's readily determinable. Then if it's not readily determinable, then we could use the lessee's incremental borrowing rate.

However, and this is really big for nonprofits, all organizations other than public business entities, PBEs, and by definition, a nonprofit cannot be a public business entity. They could be public nonprofits but not public business entities.

For all nonprofits, they may elect to use a risk-free rate to measure lease liabilities. I would assume that most nonprofits would opt to do that.

WILLIAMS: The lease standard is very extensive. Allen reviews some other important provisions.

FETTERMAN: The standard provides guidance on the lease term. It says that renewal options will be included in the lease term only if the lessee is reasonably certain to exercise the option based on relevant economic factors considering renewal terms and the degree of asset customization.

Also, short-term leases with terms of 12 months or less without renewal options that are reasonably certain to be exercised are not required to be recognized on the balance sheet.

The standard will be applied on a modified retrospective approach at the beginning of the earliest year presented with comparative periods required to be in accordance.

Theoretically, if you adopted, I'm going to say calendar year 2022, and you have comparative financial statements for 2021 under that approach, the beginning of the earliest year presented is 2021. Even though we're adopting it in 2022, we're going to have to restate 2021 to be in accordance. Or we have an option. We can elect to apply it using a cumulative effect adjustment to net assets at the beginning of the year of adoption, which would be 2022. Then comparative periods such as 2021 are not required to be in accordance with the new standard. Obviously, the client has the choice, the nonprofit or any organization has a choice, which way they want to go on that.

WILLIAMS: Allen offers his opinion on how nonprofit organizations should approach adoption.

FETTERMAN: I certainly would recommend the cumulative effect adjustment at the beginning of the year of adoption because there's no need to restate the prior year. Also, at adoption, we need not reassess lease classification. If we have leases already and they're classified as operating leases, we'll continue to classify them as operating leases. If they're classified as

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t capital leases under the old standard from many years ago, we would then classify them as finance leases. At the time of adoption when discounting the remaining lease payments, a question has been asked by a number of people. Does the entity have to go back for each lease and determine what the historical rate was in effect at the commencement of that lease? The answer is no.

We have a practical expedient to use the discount rate in effect at the beginning of the year of implementation, including comparative years. We can use one discount rate for all leases when we adopt and implement this lease standard. The last thing I want to mention about the standard is the accounting by entities that own assets, that is lessors, remains largely unchanged.

SURRAN: In April of 2020, the Financial Accounting Standards Board issued a question-and-answer document to address stakeholder questions on the application of the lease accounting guidance for lease concessions related to the COVID-19 pandemic.

Many lessors provided lease concessions to tenants impacted by the economic disruptions caused by the pandemic. As a result, the FASB staff developed the Q&A to respond to frequently asked questions and to help stakeholders navigate the guidance in this area.

For concessions related to the effects of the COVID-19 pandemic, an entity will not have to analyze each contract to determine whether enforceable rights and obligations for concessions exist in the contract and can elect to apply or not apply the lease modification guidance in Topic 842 Leases or Topic 840 Leases to those contracts.

WILLIAMS: The pandemic has certainly had an impact on leases. Allen Fetterman provides his insights related to this issue.

FETTERMAN: Because of the COVID-19 pandemic, many lessors are providing lease concessions to their lessees as a way of basically holding onto their leases, for example, payment forgiveness, deferral of payments. There've been a lot of those. Subsequent changes to lease payments that are not stipulated in the original lease are generally accounted for as lease modifications under Topic 842 or 840, depending whether you have adopted the new lease standard or not yet, 842 versus 840.

FASB issued a staff Q&A to address these COVID-19 related lease concessions. What it says is entities may elect to account for lease concessions related to COVID-19 as if enforceable rights and obligations for those concessions actually existed in the original lease.

Entities do not have to review the contracts to see if rights and obligations for lease concessions actually exist. Entities do not have to, but may apply the lease modification, accounting requirements in Topics 842 and 840 as a result of these concessions. Entities should provide disclosures about material concessions, granted, or received, whether if they're a lessee they've received a concession, they should disclose the nature and amounts of these concessions.

But the key on this one is that, and this is a staff Q&A, so you can follow it, is that if you get a lease concession, you don't have to look back to determine if that was in the original lease. You can apply it immediately.

WILLIAMS: Another new standard that is drawing a lot of attention relates to credit losses. It primarily applies to financial institutions, but it does also apply to nonprofit entities.

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t FETTERMAN: Well, the standard changes the financial accounting model applicable to all financial instruments other than those measured at fair value. Those are not covered by the standard.

Included for nonprofits, for example, would be loans receivable, programmatic loans receivable, trade receivables.

Now, understand with all that, contributions receivable and most grants receivable, if following the contribution model, are scoped out because there's no credit being granted on a contribution receivable, on accounts receivable from a sale, obviously, the seller is granting credit to the purchaser, not so with contributions receivable. It doesn't apply to those.

The impairment model is changing from an incurred loss model to an expected loss model.

In essence, the recognition of the loss is being accelerated. It requires an entity to measure all Current Expected Credit Losses, CECL. You might've heard the term CECL. That's what it stands for. Current Expected Credit Losses requires an entity to measure all of those over the contractual life of a financial asset. The current conditions and the broader range of reasonable and supportable information is now to be used to make credit loss estimates. An organization would record the difference between the amortized cost and the amount to be collected as an allowance for credit losses.

WILLIAMS: But will it have a material impact on not-for-profit organizations?

FETTERMAN: Most nonprofits have been recognizing receivables at fair value when the receivable is first set up. Whether it's a sale of an item or a loan receivable, they've been recognizing it appropriately all these years. I know even when I was in practice and I'm retired now for almost 18 years, most of my clients had things like loan receivables and accounts receivable were recognizing it at fair value and recognizing the loss immediately. In other words, not recording it at the full amount of the loan or the account receivable, what they expect to collect. Probably, this statement is not going to have a material impact on most nonprofit entities.

WILLIAMS: Another topic that seems to consistently be on the FASB’s agenda is goodwill and intangible assets. Allen reminds us about an option that is available to nonprofits.

FETTERMAN: Well, this was ASU 2019-06, which extended an option that had been available to private companies, to the nonprofit sector. The ASU that applied to private companies was 2014-02. It was out a few years.

The extension to the nonprofits was 2019-06. It took almost five years for this to be applicable to nonprofits. A nonprofit entity that has goodwill on its books, and obviously, that means not many nonprofits have goodwill on their books but if they elect these accounting alternatives, they would amortize the goodwill over 10 years or less if appropriate on a straight-line basis and test for impairment only when a triggering event occurs that indicates that the fair value of the entity may be below its carrying amount. It would do away with the annual test of impairment. It would only test for impairment when a triggering event occurs.

WILLIAMS: In 2020 the FASB issued ASU 2020-07, Presentation and Disclosures by Not-for-Profit Entities for Contributed Non-Financial Assets, a standard

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t on gifts-in-kind that will impact many nonprofit entities. Allen explains its impact in detail.

FETTERMAN: Early on in this project, FASB decided to limit it to contributed nonfinancial assets. It will be effective for fiscal years beginning after June 15, 2021. The first time it's going to be in effect will be years ending June 30, 2021, and then moving forward. Early adoption is permitted.

I mentioned that in the title, it's presentation and disclosures. It is not a measurement standard. It's purely a presentation and disclosure standard. Retrospective application will be required to all periods presented. What it will do is it will improve transparency in the reporting by not-for-profits of contributed non-financial assets.

Now, sometimes we call them gifts in kind or people like to use the acronym, GIK, gift in kind, G-I-K. Because there'll be enhancements in the presentation and disclosure. Now, what are GIKs?

In this standard GIKs include fixed assets, such as land, building and equipment. The use of fixed assets or utilities, materials or supplies such as food, clothing, and pharmaceuticals, intangible assets, services, donated services, and unconditional promises of those assets are all covered by this standard.

As I mentioned, the standard does not change existing recognition and measurement requirements. It does not address valuation. It requires not-for-profits to present contributed non-financial assets as a separate line item in the statement of activities apart from contributions of cash and other financial assets.

WILLIAMS: Allen discusses the disclosure requirements of ASU 2020-07.

FETTERMAN: Well, there's a required quantitative disclosure. We have to disclose contributed non-financial assets recognized on the Statement of Activities disaggregated by category, that depicts the type of contributed non-financial assets, services, pharmaceuticals, building, equipment, each of those would be a separate type of category. You would have to quantitatively disclose the amount for each of these categories.

Once we do that, then we get into the required qualitative disclosures. That starts with, for each category we have to disclose information about whether the contributed nonfinancial assets were either monetized or utilized. Monetized meaning sold. Monetized or utilized during the reporting period. If utilized, a description of the programs or other activities in which those assets were used.

Then we have to disclose the nonprofit’s policy if they have such a policy about monetizing, rather than utilizing the contributed non-financial assets. We need to disclose the description of any donor- imposed restrictions associated with the contributed non-financial assets. Also, the valuation techniques and inputs used to arrive at a fair value measure at initial recognition.

Then the last qualitative disclosure, which is going to be less common, we need to disclose the principal market or most advantageous market used to arrive at a fair value measure if it's a market in which the recipient not-for-profit is prohibited by a donor imposed restriction from selling or using the contributed non-financial assets.

I think if you look at that, you'll see that you're not going to come across that too frequently.

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t SURRAN: In 2016 the FASB issued ASU 2016-14, Not-for-Profit Entities: Presentation of Financial Statements of Not-for-Profit Entities. ASU 2016-14 simplified and improved how not-for-profit entities classify net assets as well as the information presented in financial statements and notes about liquidity, financial performance, and cash flows. The ASU affected not-for-profit organizations and the users of their general purpose financial statements.

Not-for-profit organizations that were affected include charities, foundations, colleges and universities, health care providers, religious organizations, trade associations, and cultural institutions among others.

WILLIAMS: ASU 2016-14 has been effective for a few years now. However, many practitioners and nonprofit executives missed a provision of that standard dealing with donated services received from an affiliate. Allen Fetterman explains.

FETTERMAN: It was missed by a lot of nonprofits. It was also missed by a lot of their auditors. This was 2016-14, Presentation of Financial Statements of Not-for-Profit Entities. It talks about there is a provision there that's been missed.

It provides guidance related to equity transfers. Previously, it applied only to not-for-profit business- oriented healthcare entities, and it was sitting in the healthcare guide. It says that the increase in net assets associated with services received from personnel of an affiliate for which the affiliate does not charge the recipient not-for-profit should be reported as an equity transfer.

Before the change in ASU 2016-14, a nonprofit that received donated services from an affiliate was recording the credit as contribution revenue. Now, the credit should be reported as an equity transfer. And equity transfers should be reported separately as a change in net assets after a subtotal such as change in net assets before equity transfers.

Then you'd have equity transfers and then change in net assets. The debit side of the entry would continue to be reported as an expense, such as salaries, which would be functionalized, or if it's an asset it would be reported as an asset.

It’s the credit side of this journal entry that would now be recognized as an equity transfer, as opposed to contribution revenue.

WILLIAMS: Allen discusses the other activities concerning nonprofit entities that the FASB has been working on.

FETERMAN: Recently, FASB, they've been looking into a lot of things for nonprofits.

First of all, there was a project that FASB had on its agenda. Consolidation of a not-for-profit by a for-profit sponsor. That project has been removed from the agenda. FASB determined that there's no significant diversity in practice to warrant a project. Then FASB has received feedback from the NAC, the Nonprofit Advisory Committee. And they got that from nonprofit stakeholders through a survey.

Here's what the nonprofit stakeholders would like FASB to look into. Defining intermediate operating measures for nonprofits. You might recall 2016-14; FASB decided in that standard not to define intermediate operating measures. Improve the consolidations model for nonprofits. Make targeted improvements to accounting for government grants. Provide additional guidance on the valuation of non-financial assets and

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t provide additional guidance on MD&A Management Discussion and Analysis, for nonprofits, which FASB briefly looked into at the very beginning of the project that led to 2016-14, but then they decided that it wasn't necessary.

These are all areas that FASB may in the near future start to get involved in. There's really no way of telling.

WILLIAMS: The COVID-19 pandemic has raised several accounting questions that have an impact on not-for-profit organizations. Allen brings us up to date.

FETTERMAN: There have been two accounting issues, amongst many operating issues and auditing issues when it comes to the pandemic.

One of these accounting issues has to do with how we account for the Paycheck Protection Program or PPP loans. The AICPA issued a technical Q and A; I want to give you the number if you want to look it up as a long name, it's 3200.18, and it comes up with two approaches to account for loans under the PPP program.

One is a loan model and the other is a conditional contribution model. Whether the nonprofit expects to repay the loan or expects it to be forgiven either way, the nonprofit may account for the loan as a financial liability in accordance with ASC 470, which is debt and accrue interest on the liability. In other words, account for it as debt, a liability. If and when the loan is forgiven, the nonprofit would record a gain on extinguishment.

If the nonprofit chooses not to follow ASC 470, and I expect that most nonprofits will choose not to follow ASC 470, which is debt. If they expect to meet the PPP's eligibility criteria for loan forgiveness, and they conclude that the loan represents in substance a grant, it should account for the loan under ASC 958-605, as a conditional contribution.

When they get the loan, the cash inflow would be treated as a refundable advance, and a contribution would be recognized once the conditions of release have been substantially met or explicitly waived.

WILLIAMS: Another topic that relates to the pandemic is the extension of due dates on Single Audit Reports. Allen gives us the latest information on the due dates.

FETTERMAN: There has been an extension of the due dates a few times already. Appendix VII of the 2020 OMB Compliance Supplement Addendum, and Appendix VII is Other Audit Advisories, provided for a three-month audit submission extension for single audits of 2020 year-ends through September 30, 2020 year-ends, only if the recipient expended COVID 19 funding reported on the SEFA.

For example, the single audit deadline for September 30, 2020 year-ends, was extended with that provision from June 30, 2021, which is the standard nine months, through September 30, 2021. That was a three-month extension.

Then OMB came out with memorandum M-21-20, in the year 2021, which provides Single Audit due date extensions to recipients and subrecipients, that have not yet filed Single Audits with the Federal Audit Clearinghouse, as of the date the memo was issued, which is March 19, 2021.

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t It covers organizations that have fiscal year-ends through June 30, 2021, and it extends it through six months beyond the normal due date. It applies to all entities who are required to undergo a single audit, not just those that have COVID-19 funding. Besides the dates going out further, that's the big change from the previous extension that we talked about, just a moment ago.

For example, if you have a June 30 fiscal year-end, June 30, 2020, the original due date, nine months later, would have been March 31, 2021. It's been extended by six months to September 30, 2021.

If your fiscal year-end is December 30, 2020, the original due date was September 30, 2021, extended six months to March 31, 2022. Lastly, if you have a fiscal year-end of June 30, 2021, which just finished, just happened, the original due date nine months later would have been March 31, 2022. It's been extended six months to September 30, 2022.

WILLIAMS: Allen opines on the importance of this extension for nonprofits.

FETTERMAN: This is a really important extension for nonprofits that undergo Single Audits, not just those that receive COVID-19 funding and not those, as in an earlier extension, which we didn't talk about today, not just those who have lost operational capacity due to COVID-19. Any organizations that undergo a Single Audit. Again, this extension does not require recipients and subrecipients to seek approval for the extension.

Recipients and subrecipients should, however, maintain documentation for the reason for the delayed filing. Again, offsite working, staff cutbacks, people are sick, that kind of stuff.

And recipients and subrecipients, taking advantage of this extension, would still qualify as a low-risk auditee, assuming all the other requirements are met.

WILLIAMS: The AICPA Governmental Audit Quality Center provides Single Audit guidance to practitioners. Allen gives us an update on their recent activity.

FETTERMAN: First of all, you have to understand, there's been a lot of confusion as to when to report costs incurred, or lost revenue, if that's applicable on the SEFA. When do we report it?

This is due, in part, to the short time between the passage of the CARES Act, that's the Coronavirus Act that includes so many different funding programs, and the receipt of funding by nonprofits, sometimes before the award terms or conditions were even established. Also, some programs allow costs to be charged both before and after the award was made.

In February of 2021, the AICPA Governmental Audit Quality Center, or GAQC, issued a non-authoritative guidance on the reporting of certain COVID-19 awards on an accrual basis SEFA.

And this guidance is available on the GAQC website. It provides illustrative scenarios to assist in determining which fiscal year to report costs incurred on an accrual basis, SEFA.

In addition, the GAQC updated its summary of uniform guidance applicability, for new COVID-19 related federal programs as of February

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t 16, 2021. This is also available on the GAQC website. It provides guidance regarding the applicability of the uniform guidance to specific federal programs. However, it does not apply to Single Audits of the Provider Relief Fund, which is for the healthcare entities.

WILLIAMS: Allen Fetterman concludes the segment with his final thoughts.

FETTERMAN: What I've said before many times, there is so much going on in the world of accounting and auditing that impacts not-for-profit entities and their auditors. It's nice if you attend CPE sessions or you're here listening to us today, but you also, those who listen, are also, I believe it's incumbent on them to read the standards and read more articles on it. There's just so much going on; it's difficult to absorb it all, without constantly refreshing your memory.

We talked today about a lot of accounting issues. We talked about some single audit issues. COVID 19 is impacting so many things that we've discussed, the deferring accounting standards, impacting on a single audit performance and due dates. Today, we didn't even touch on all the changes in the world of audit reporting. There's a lot happening.

I guess my thought is, just keep on trucking. Just keep trying to learn, stay up to date, attend CPE sessions, do more reading. Because in order to serve your clients, you need to be as up to date as possible.

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Evaluation Form

Please rate the segments on the September 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. Employee Stock Purchase Plans – Why Offer One? _____ _____ _____ _____ _____

2. Accounting & Valuation of SPACs _____ _____ _____ _____ _____

3. Related Party Transactions – A Recurring Issue _____ _____ _____ _____ _____

4. IRS Updates _____ _____ _____ _____ _____

5. Revenue Recognition, Leases and Other Accounting Updates for NFPs _____ _____ _____ _____ _____

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:

RFR Kaplan Professional Education

332 Front Street, Suite 501 La Crosse, WI 54061

Name (please print):

Title:

Firm:

City/State:

Date:

Knowledge Discussion Leader/ of Subject Teaching Skills

Segment 1: ___________________ ___________________ ___________________ Discussion Leader’s name

Segment 2: ___________________ ___________________ ___________________ Discussion Leader’s name

Segment 3: ___________________ ___________________ ___________________ Discussion Leader’s name

Segment 4: ___________________ ___________________ ___________________ Discussion Leader’s name

Segment 5: ___________________ ___________________ ___________________ Discussion Leader’s name

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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. 2017-02 October – 1

ASU No. 2020-05 September – 5

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 Rev. Proc. 2016-47 December – 1

IRS Rev. Proc. 2020-23 October – 4

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 Changes and Error Corrections, Exposure Draft on August – 5

Accounting, diversity in December – 2

AICPA Audit Guide, 2020 May – 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, pandemic and October – 1

ASC Topic 842, transition to Jult – 2

Big data, finance and January – 4

Bitcoin and Ethereum December – 3

Blockchain, accounting and June – 1

Blockchain, managing inventory & transactions with June – 1

Blockchain, tax implications of December – 3

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.

October 2020 – September 2021

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Brand licensing, ethics and January – 3

Brand, personal May – 3

Business roundtable statement May – 2

CAA, disaster relief and February – 4

CAA, tax relief and February – 4

CAMs, inventory observation challenges October – 2

CARES Act February – 1

CARES Act, not-for-profits and February – 5

CECL, COVID-19 and April – 2

CECL, nonprofits and September – 5

Common Reporting Standard (CRS) November – 2

Consolidated Appropriations Act 2021 (CAA) Feb. – 4; April – 4

Corporate misconduct, reasons for May – 2

Critical audit matters – see: CAM

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 Nov. – 3; Sept. - 4

Debt Instruments, significant modifications of October – 4

De minimis use rule November – 1

Digital assets, tax implications of December – 3

Digital currency transactions, IRS and July – 4

Diversity, equity and inclusion (DEI) December – 2

Dodd-Frank Act, transparency and October – 4

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

Employee stock options April – 1

Employee stock ownership plan (ESOP) November – 4

Employee stock purchase plans (ESSPs) September – 1

Environmental, social and governance (ESG) issues Oct. – 4; April – 3

Ethics and compliance, management of May – 2

ETSC, definition of November – 4

Executive compensation, COVID-19 and October – 2

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

FATCA, Common Report Standard and November – 2

Five-year lookback rule November – 1

Flexible Spending Account (FSA) April – 4

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Fraud triangle October – 2

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

Global Forum on Transparency and Exchange of Information November – 2

Going concern analysis October – 2

Going concern considerations February – 5

Goodwill impairment, COVID-19 and October – 1

Governmental Accounting Standards Board (GASB) April – 5

Human capital April – 3

IAS 24, related parties and September – 3

Inspection report, PCAOB July – 2

Internal audit and internal controls, difference between November – 3

Internal auditing, COVID-19 and January – 1

Internal auditing, technology and January – 1

Internal controls programs, advantages and disadvantages of November – 3

Internal controls, not-for-profits and February – 5

Internal controls, risk assessment and November – 3

International Ethics Standards Board for Accountants – see: IESBA

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

IRS Form 941X, existing and revised October – 3

IRS Notice 2020-69, purpose of GILTI under November – 1

Leases, accounting for July – 2

Leases, nonprofits 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

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

Payroll tax deferral Oct. – 3; Dec. – 4

PCAOB inspection report July – 2

Personal brand, auditing your May – 3

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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

Public Company Accounting Oversight Board (PCAOB) July – 2

Qualified retirement plans November – 4

Regulation S-K April – 3

Related party transaction September – 3

Retirement plan regulations, changes to February – 4

Return on investment (ROI) July – 4

Revenue and expense recognition, three approaches June – 5

Revenue recognition, nonprofits and September – 5

Revised Uniform Unclaimed Property Act (RUUPA) June – 2; June – 3

SBA, second program February – 1

SEC, related party transactions and September – 3

SEC, SPACs and September – 2

SECURE Act November – 4

Social credit model January – 4

Special purpose acquisition companies (SPACs) July – 1; Sept. - 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) Oct. – 4; April – 3

Sustainability, long-term April – 3

Task Force on Climate-related Financial Disclosures (TCFD) October – 2

Tax challenges with digital and global economy April – 2

Tax Cuts and Jobs Act – see: TCJA

Tax-exempt status, activities that jeopardize July – 5

TCJA, IRC Section 118 and October – 4

Taxpayer First Act August – 4

Tax Relief and Health Care Act of 2006 August – 4

Technology, GASB and April – 5

Transfer pricing April – 1; April – 2

Triggers, single vs. double stock option April – 1

Trusts and estates, final regulations for November – 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

Virtual currencies, valuation of December – 3

Whistleblower complaints August – 4

W-2 reporting & deferral, IRS guidance on December – 4

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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.