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EBP Commentator - Summer 2017

Wed, 09/20/2017 - 12:00am


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  Table of Contents     LOL... ROFL… BRB…

With the advent of social media, there has been a proliferation of new acronyms making their way into our everyday language. Even those who are not social media savvy may likely recognize some of these popular acronyms: LOL - Laughing Out Loud; ROFL – Rolling On Floor Laughing; BRB – Be Right Back. Similar to the world of social media, there are many acronyms pertaining to Employee Benefit plans (EBP). This edition explores several EBP acronyms we believe would be beneficial for plan sponsors to understand.

    
RMD Contributed by Wendy Schmitz
 
RMD is short for Required Minimum Distributions. The Internal Revenue Service (IRS) does not allow retirement funds to be kept tax free indefinitely. At age 70½ participants are required to withdraw a minimum amount from their Individual Retirement Account (IRA), Simplified Employee Pension (SEP) IRA, SIMPLE IRA (Savings Incentive Match Plan for Employees), or retirement plan account (with some exceptions for Roth IRAs).

These distributions are not generally tax free nor can taxes be avoided by rolling the RMD into another tax-deferred account. The account owner is taxed at their regular income tax rate on the amount of the RMD withdrawn. Depending on the dollar amount of the RMD, no tax withholdings may be deducted from the amount distributed; however, the taxes would then need to be trued up on the account owner’s annual federal tax return.

Sponsors of retirement plans (including 401(k), 403(b) and defined benefit pension plans) are required to ensure that RMDs occur timely. Despite the fact that a participant may be receiving RMDs[1], the sponsor is required to continue to make contributions on behalf of that participant (in accordance with the plan document) as well as allow the participant to continue to make salary deferrals, if appropriate.

For a participant’s first RMD, the RMD may be delayed until April 1st of the year after the participant turns age 70½. For all subsequent years (including the year in which the participant first receives an RMD which was delayed to April 1st), RMDs must be made by December 31st. RMDs may also be delayed for participants who are still employed (although generally not available to employees who are deemed to be a 5% owner and certain relatives of such an owner) as well as for older 403(b) accounts (generally pre-1987 accounts).

Required minimum distribution rules also apply after a participant’s death. In general, the IRS requires RMDs of the participant’s death benefit even if death occurs before age 70½. Consultation with a qualified tax expert would be needed as death benefits are a complicated tax area.

Watch for changes in plan demographics since RMDs may become more common with an aging participant population. Some plan sponsors employ third party service providers, such as the plan record-keeper, to administer the RMDs. However, the ultimate responsibility of ensuring the plan is operated in accordance with the IRS rules and regulations still remains with the plan sponsor. Plan sponsors should obtain an understanding of the processes used by the service provider as well as what input or approvals the service provider requires from the plan sponsor in order to perform the distribution. Additionally, sponsors should monitor the service providers to ensure the RMDs are made on a timely basis.

There are consequences if RMDs are not made timely. For the individual participant, the amount not withdrawn timely is taxed at a 50% rate. In a worst case scenario, a failure to make timely RMDs to eligible participants could cause loss of the tax exempt status for the plan, which would have devastating effects on all plan participants as well as significant tax consequences for the plan sponsor. However, this is generally rare as regulators try to avoid plans disqualifications, due to the harm it causes participants. Regulators instead provide sponsors with the opportunity to correct operational defects, such as this, through the IRS correction program, Employee Plans Compliance Resolution System (more commonly referred to as EPCRS, yet another industry acronym). Under EPCRS, a plan sponsor may use either the Self-Correction Program (SCP) or the Voluntary Correction Program (VCP) to correct RMD failures. There are benefits to both methods. The SCP, which is generally for small timely identified errors, does not require a filing or filing fee with the IRS whereas the VCP requires filing of a form and payment of a filing fee. A key benefit to the VCP is that the IRS will waive the 50% participant tax if the plan sponsor requests the waiver as part of the filing submission. If the VCP is not used and the participant requests a waiver, each affected participant or beneficiary must individually apply for a waiver of the 50% tax using the Form 5329 as part of their federal income tax return.

Understanding and monitoring RMDs is an important focus for sponsors since there are, to put it in social media terminology, consequences IRL (In Real Life) for missed or untimely RMDs. On a more serious note, RMDs are complex and consultation with a qualified tax expert is recommended. BDO is available to assist sponsors and fiduciaries in addressing the rules and considerations associated with RMDs.

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MEP Contributed by Mary Espinosa
 
Multiple Employer Plans (also known as MEPs) are sometimes incorrectly interchanged with Multiemployer Plans. Despite the misperception, these terms are not the same and are actually very different:
 
  • MEPs are either defined benefit or defined contribution retirement plans adopted by two or more employers that are not treated as related entities (in other words, the employers are not members of a controlled group, commonly controlled group or affiliated service group).
  • Multiemployer refers to a plan maintained under one or more collective bargaining agreements to which more than one employer (usually within the same industry, such as a labor union) is required to contribute.
 
MEPs can be structured in various ways. An open MEP is offered to employers that have no connection to each other aside from their participation in the MEP. Open MEPs are generally provided by an independent investment advisory firm or an organization created specifically to provide benefits to smaller employers. Alternatively, a closed MEP is generally sponsored by an industry or trade group. In a closed MEP, the employers must have the ability to control or exercise authority over the MEP. A Professional Employer Organization (PEO) is an arrangement whereby the PEO hires the client company’s employees and is the employer of record for tax and insurance purposes. The MEP is sponsored by the PEO and adopted by the PEO’s clients. A common ownership MEP is when the adopting employers do have some common ownership, but the ownership is insufficient for them to be considered related employers under the Internal Revenue Code (IRC).
 
Two or more employers can also pool their contributions to provide group health and other welfare benefits, such as dental, vision, life and disability in Multiple Employer Welfare Arrangements (MEWAs). Contributions can be made by both employees and employers based on the estimated costs associated with the number of covered employees. MEWAs are offered by the same types of organizations that sponsor MEPs.
 
Under the IRC, a MEP is treated as a single plan and must comply with certain qualification rules, including the exclusive benefit requirement, eligibility and vesting, etc. However, a MEP may or may not be treated as one plan under the Employee Retirement Security Act of 1974 (ERISA). For example, open MEPs usually do not meet the common interest criteria and, as such, each adopting employer is considered to be maintaining a separate plan and therefore each plan potentially may have both a separate Form 5500 filing requirement as well as a separate audit requirement, depending on the number of participants. In its Advisory Opinion 2012-04A, the Department of Labor (DOL) discusses the criteria it considers in determining whether a MEP may or may not be treated as one plan. Such criteria includes how members are solicited, who is entitled to participate, the purposes for which the association was formed, and who controls and directs the activities and operations of the benefit program.
 
MEPs and MEWAs may provide a solution for small employers looking to provide large plan benefits to their employees, while at the same time reducing administrative and cost burdens and minimizing fiduciary responsibility (including reporting and disclosure requirements). However, there are complexities associated with these plans. For instance, depending on whether the MEP is structured as closed or open, there may be a need for separate adoption agreements for each adopting employer, etc. Additionally, there may be limitations on an employer’s ability to exit a MEP and the ability of that employer’s employees to take their money out of the plan. Since the exit of one employer would not ordinarily terminate a MEP, technically the plan has not experienced a distributable event and, if there is no distributable event, employees would then be required to wait until a distributable event occurs in order to take a distribution.

The IRS provides guidance on MEPs through its IRS Internal Revenue Manual, Part 7, Chapter 11, Section 7 (Section 6 discusses multiemployer plans). IRS FAQs also address frequent questions the IRS receives.

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HWC Contributed by Joanne Szupka and Chelsea Smith Brantley

There’s no doubt about it – how we communicate (HWC) benefit information to employees can be challenging. According to a recent study released by the International Foundation of Employee Benefit Plans (IFEBP), 65% of the employers noted employee benefit education is a high priority[2] for their organization. Despite prioritizing such education, only 19% of the respondents indicated their employees have a high level of understanding regarding employee benefits. This low level of understanding may be linked to employees not opening or reading employer communication materials as 80% of the employers surveyed cited this as a problem. Clearly, there is a communication gap.

Communicating with employees about available benefits (whether retirement, medical or other) is a key responsibility of Human Resource personnel. Earlier this year, we conducted our own survey as to how people prefer to receive their information. Here is how the results stacked up:
 
  An overwhelming majority (92%) noted that they prefer email for benefit-related communications whereas only 8% would opt to receive the information via video-conference. Our survey respondents voted down other methods of communication, such as in-person, over the phone, Skype or text.

Of course, how such information is communicated is only one component of effective benefit plan communications. Here are three critical mistakes typically found in benefits communication and how to fix them:



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LUFTR Contributed by Darlene Bayardo and Chelsea Smith Brantley 
 
Here are some of the Latest Updates From The Regulators (LUFTR):
  Hurricanes Harvey and Irma Relief Due to the impact of Hurricanes Harvey and Irma, government agencies have announced relief measures, several of which directly impact employee benefit plans as highlighted below:
 
  • The IRS has granted relief to impacted taxpayers, which includes the postponement of several tax filing and payment deadlines.  The relief provides an automatic extension of time to file certain tax returns through January 31, 2018. This includes taxpayers who had a valid extension to file their 2016 returns (including Form 5500) through October 16, 2017.
  • The IRS also announced that employer-sponsored retirement plans can make participant loans and hardship distributions available to participants and certain members of their families who live or work in the affected disaster areas designated for individual assistance by the Federal Emergency Management Agency (FEMA). It relaxes procedural and administrative rules that normally apply to participant loans and hardship distributions, including the abatement of the six-month ban on employee contributions following the hardship distribution. This relief also allows individuals who live outside the disaster area to take a loan or hardship distribution to assist family or other dependents who live or work in the disaster area. However, the IRS has stressed that the tax treatment of such loans and distributions remains unchanged. The relief is available through January 31, 2018.
  • The PBGC has announced it is waiving late premium payment penalties and extending certain other deadlines for affected plans. The PBGC’s announcement provides information on the disaster relief, including which plans are eligible and how to make a claim for relief.
 
AICPA
  • The AICPA has extended the public comment period on the proposed Statement on Auditing Standards (SAS), Forming an Opinion and Reporting on Financial Statements of Employee Benefit Plans Subject to ERISA from the original deadline of August 21, 2017, to September 29, 2017. As discussed in our Spring 2017 edition, there are significant proposed changes in the Exposure Draft. Responses should be submitted to Sherry.Hazel@aicpa-cima.com.


IRS
  • The IRS issued a memorandum in April 2017 to the Employee Plans (EP) staff confirming that a cash balance formula based on only a portion of the participant’s annual compensation can meet the “definitely determinable” requirement so long as the formula is not subject to employer discretion under the plan provisions. The memorandum states that, if a plan provides for employer discretion to determine the portion of compensation taken into account, that plan violates the “definitely determinable” rule and therefore the plan will not be treated as a qualified plan for tax purposes. On the other hand, if the plan terms do not allow for employer discretion, benefits will be considered “definitely determinable” even though the employer may have the inherent ability to determine the amount of compensation. Sponsors of cash balance plans should assess the cash balance formulas to ensure they meet the “definitely determinable” requirement under this guidance.

  • The IRS released Notice 2017-37 in June 2017, which provides the Cumulative List of Changes in Plan Qualification Requirements for Pre-Approved Defined Contribution Plans for 2017. This list identifies updates in the qualification requirements of the IRC, which must be incorporated in plan documents submitted to the IRS when requesting an opinion letter through the pre-approved plan program.

  • IRS Revenue Procedure 2017-41 released July 2017, outlines revised IRS procedures regarding issuance of opinion letters on qualification of pre-approved plans and discusses the elimination of separate pre-approved letter programs for volume submitter and master and prototype programs through the creation of a single opinion letter program. The Rev. Proc. is intended to encourage employers to switch from individually designed plans to pre-approved plans and is effective October 2, 2017.

  • In July 2017, the IRS released Rev. Proc. 2017-43, which includes changes to the existing procedures for a suspension of benefits under a multiemployer defined benefit pension plan that is in “critical and declining status.” The Rev. Proc. must be followed and is effective for applications submitted to the Treasury Department for approval of a suspension of benefits on or after September 1, 2017.

  • As discussed in our Spring 2017 edition, the IRS recently issued guidelines for substantiating safe-harbor hardship distributions from 401(k) and 403(b) retirement plans. The IRS hosted a podcast in July 2017, that addressed guidelines provided to IRS agents who audit plans on how to review hardship distributions where sponsors have elected to use the “summary substantiation” method. The discussion highlighted that plan sponsors and third party administrators should review the guidelines in conjunction with plan procedures and processes when setting plan procedures. A recording of the podcast is available at https://www.stayexempt.irs.gov/Home/Resource-Library/Retirement-Plan-Resources.

 

​DOL
  • The DOL’s fiduciary rule currently has a phased-in transition period (with respect to the rule’s specific disclosures and representations) that ends January 1, 2018. The DOL recently requested information from the public regarding the rule, including whether the compliance date should be delayed. It has now asked the Office of Management and Budget for a delayed compliance deadline of 18 months until July 1, 2019. In the request, the DOL noted that it is contemplating lessened restrictions on the types of transactions permitted under the rule, which affects certain insurance products and rollovers of IRAs.

  • In August 2017, the DOL issued FAQs explaining the interaction of the fiduciary rule with the 408(b)(2) service provider fee disclosure rules. The FAQs address:

    • The impact of the fiduciary rule on 408(b)(2) disclosures as covered service providers who provide (or expect to provide) fiduciary services are generally required to affirm whether they are acting as a fiduciary.

    • Whether recommendations to participants or IRA owners to contribute or increase contributions to a plan or IRA constitute fiduciary investment advice.

    • Whether recommendations to employers and other plan fiduciaries on plan design changes intended to increase plan participation and plan contribution rates constitute fiduciary investment advice.

PCAOB

The Public Company Accounting Oversight Board (PCAOB) has adopted a new auditing standard, The Auditor's Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, that applies to audits conducted under PCAOB standards, including audits of employee benefit plans that file an annual report with the Securities and Exchange Commission on Form 11-K.


The new standard includes a requirement for the auditor's report to disclose the tenure of an auditor, specifically the year in which the auditor began serving consecutively as the entity's auditor. In addition, it will also include the phrase, "whether due to error or fraud," in describing the auditor's responsibility under PCAOB standards to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements.

Plans subject to filing a Form 11-K are exempt from the requirement to include a discussion of the critical audit matters[3] (CAMs) in the auditor’s report, but may choose to do so voluntarily. The standard is effective for audits for fiscal years ending on or after December 15, 2017.

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Events, People and Places Society for Human Resource Management (SHRM) Annual Conference and Exposition

EBP Assurance and Tax professionals, Grand Rapids Assurance Director Luanne MacNicol (left) and ERISA National Practice Leader and Specialized Tax Services Managing Director Kim Flett (right) attended the national SHRM conference in New Orleans, Louisiana in June, 2017. Representing BDO at the executive booth with the theme “We’ve Got You Covered,” Luanne, Kim and other BDO professionals met with attendees from all over the world. Employee benefit plans were the topic of discussion with matters ranging from plan audits, compliance reviews, plan design and other benefits administration. This important conference provided an opportunity to demonstrate BDO’s skilled knowledge and expertise in the many complex areas of employee benefit plans.

  Meet BDO’s National Practice Leader for Employee Benefit Plan Audits

Beth Garner leads BDO’s National Employee Benefit Plan audit practice. A partner in BDO’s Atlanta office, she is actively involved in EBP activities within both the firm and various industry and professional organizations, including the AICPA Employee Benefit Plan Audit Quality Center Executive Committee. Beth brings a depth of experience as a long-time EBP auditor as well as a client’s perspective on the challenges facing plan sponsors from her prior private industry career experience. Through her leadership, BDO continues to pursue excellence in both audit quality and client service.


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Our EBP Center of Excellence is dedicated to assisting plan sponsors in addressing their various EBP needs. For more information on BDO’s EBP services, please contact a member of our practice leadership:
 

Beth Lee Garner
National Practice Leader      Luanne MacNicol, Grand Rapids
Central EBP Regional Leader   Darlene Bayardo
National Assurance   Wendy Schmitz, Charlotte
Atlantic EBP Regional Leader   Mary Espinosa, Orange County
West EBP Regional Leader   Joanne Szupka, Philadelphia
Northeast EBP Regional Leader   Jody Hillenbrand, San Antonio
Southwest EBP Regional Leader   Jam Yap, Atlanta
Southeast EBP Regional Leader    

[1] RMDs may be taken on an annual basis. Additionally, as the name implies, these distributions are just minimums; a participant may be eligible to take additional distributions, if desired.
[2] https://www.ifep.org/pdf/benefits-communication-survey-results.pdf
[3] These are matters that have been communicated to the audit committee, are related to accounts or disclosures that are material to the financial statements, and involve especially challenging, subjective, or complex auditor judgment.

Relief Measures Impacting Employee Benefit Plan Sponsors

Fri, 09/15/2017 - 12:00am
In response to Hurricanes Harvey and Irma, the IRS announced that employer-sponsored retirement plans can make participant loans and hardship distributions available to participants and certain members of their families who live or work in the affected disaster areas designated for individual assistance by the Federal Emergency Management Agency (FEMA) – relaxing procedural and administrative rules that normally apply to participant loans and hardship distributions, including the abatement of the six-month ban on employee contributions following the hardship distribution.
 
This relief also allows individuals who live outside the disaster area to take a loan or hardship distribution to assist family or other dependents who live or work in the disaster area. However, the IRS has stressed that the tax treatment of such loans and distributions remains unchanged. The relief is available through January 31, 2018.
 
The Department of Labor has issued compliance guidance for impacted plans and FAQs for affected participants and beneficiaries.
 
The Pension Benefit Guaranty Corporation (PBGC) has announced it will waive late premium payment penalties and extending certain other deadlines for affected plans. The PBGC’s announcement provides information on the disaster relief, including which plans are eligible and how to make a claim for relief.
 
BDO Disaster Response In an effort to help to those impacted, government agencies have announced relief measures, from tax extensions and hardship distributions to tax-exempt employer assistance, and even guidance on cyber threats related to hurricane relief.
  Learn More

FASB Flash Report - September 2017

Fri, 09/15/2017 - 12:00am
FASB Issues Targeted Improvements to Hedge Accounting

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Summary The FASB recently issued ASU 2017-12[1] to improve its hedge accounting guidance. This new standard simplifies and expands the eligible hedging strategies for financial and nonfinancial risks. It also enhances the transparency of how hedging results are presented and disclosed. Further, the new standard provides partial relief on the timing of certain aspects of hedge documentation and eliminates the requirement to recognize hedge ineffectiveness separately in earnings. The ASU is available here, and becomes effective for public companies in 2019 and all other entities in 2020. Early adoption is permitted.
  Background Topic 815[2] governs the accounting for derivative instruments and provides an option to elect hedge accounting. Historically, the conditions to apply hedge accounting have been quite stringent.

ASU 2017-12 more closely aligns hedge accounting with a company’s risk management activities and simplifies its application through targeted improvements in key practice areas. This includes expanding the list of items eligible to be hedged and amending the methods used to measure the effectiveness of hedging relationships. These changes are intended to allow preparers more flexibility. In addition, the ASU prescribes how hedging results should be presented and requires incremental disclosures.
  Main Provisions Expansion of Risks Eligible to be Hedged

Financial Risk Components
Under current GAAP, a hedge of interest-rate risk is only allowed for specific benchmark interest rates, i.e., LIBOR, US Treasury and the OIS rates. The ASU amends this guidance to allow other interest rates to be hedged:
  • For cash flow hedges, the concept of benchmark interest rates was eliminated. Instead, an entity can hedge any contractually specified interest rate. Therefore, variability in cash flows attributable to the prime rate or any other explicitly specified rate can now be hedged.
  • For fair value hedges, the concept of benchmark interest rates was retained. However, the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate was added to the list of eligible US benchmark interest rates mentioned above.
Nonfinancial Risk Components
  • Similar to the amendments for cash flow hedges of interest-rate risk, the ASU permits an entity to hedge the variability in cash flows attributable to changes in any contractually specified component of a nonfinancial asset. For instance, an entity may hedge just the rubber component of forecasted tire purchases instead of the entire purchase price.
Simplified Application of Interest-Rate Risk in Fair Value Hedges
To simplify and better align fair value hedges of interest-rate risk in a debt instrument with an entity’s risk management strategy, the ASU permits an entity to:
  • Measure the change in fair value of the hedged item considering only the hedged benchmark interest rate component, instead of the full contractual coupon (including credit spread).
  • Measure the hedged item by assuming it has a term that reflects only the designated cash flows being hedged, e.g., the first 3 years of a 7 year note, which was not permitted in the past for fair value hedges.
  • Consider how changes in only the hedged benchmark interest rate will affect a decision to settle a prepayable financial instrument before its scheduled maturity, and not credit or other extraneous factors, in calculating the change in fair value of the hedged item.
  • Use a “last-of-layer” method in hedging certain portfolios of prepayable financial assets. As such, prepayment risk is not incorporated into the measurement of the hedged item as that bottom layer is not expected to be affected by prepayments.
Elimination of the Separate Measurement and Recording of Hedge Ineffectiveness
The ASU eliminates the concept of hedge ineffectiveness for financial statement recognition purposes. While the hedging relationship still has to be highly effective in order to apply hedge accounting, the ineffective portion of the hedging instrument is no longer required to be recognized currently in earnings or disclosed. As such,
  • For cash flow and net investment hedges, all changes in the fair value of the hedging instrument (i.e., both the “effective” and “ineffective” portions) will be deferred in other comprehensive income and recognized in earnings at the same time that the hedged item affects earnings.
  • For fair value hedges, the entire fair value change of the hedging instrument is presented in the same income statement line that includes the hedged item’s impact on earnings.
Simplifications Related to Effectiveness Assessments and Related Hedge Documentation
The ASU includes other simplifications to hedge effectiveness assessments and the related hedge documentation:
  • If certain conditions are met, an entity may elect to perform the subsequent quarterly hedge effectiveness assessments qualitatively even if a quantitative test (e.g., regression) was required to be performed at hedge inception.  
  • An entity may assume that the hedging derivative’s maturity date and the occurrence of the forecasted transactions (e.g., forecasted sales) match if they occur within the same 31-day period or fiscal month.
  • The timing of the initial prospective quantitative hedge effectiveness test is extended up to the first quarterly effectiveness assessment date for all entities.
  • As additional relief, certain private companies and not-for-profit entities may select the method of assessing hedge effectiveness, and perform both the initial effectiveness test and all subsequent quarterly hedge effectiveness assessments before the date on which the next financial statements are available to be issued. They are required to document only the hedging instrument, the hedged item or transaction, and the nature of the risk being hedged contemporaneously at hedge inception.
  • An entity that applies the qualitative shortcut method for assessing hedge effectiveness but later determines this method to be inappropriate is allowed to change to a specified quantitative “long-haul” method (e.g., regression) without dedesignating the hedge, so long as that long-haul method was documented at inception.
 
Improvements to Presentation and Disclosure
The ASU establishes the following presentation and disclosure requirements:
  • Requires presentation of the earnings effect of the hedging instrument in the same income statement line item as the hedged item (e.g., amounts deferred in other comprehensive income for cash flow hedges of interest rate risk will be reclassified to interest expense).
  • Requires new tabular disclosures related to the cumulative basis adjustments for fair value hedges; and
  • Amends current tabular disclosures related to the effect on the income statement of fair value and cash flow hedges.
  Effective Date and Transition For public business entities, the ASU is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. For all other entities, the ASU is effective for fiscal years beginning after December 15, 2019, and interim periods beginning after December 15, 2020.

Early application is permitted in any interim period after issuance of the ASU for existing hedging relationships on the date of adoption. The effect of adoption should be reflected as of the beginning of the fiscal year of adoption (that is, the initial application date).

The transition section of the ASU specifies the following:
  • For cash flow and net investment hedges existing at the date of adoption, elimination of the separate measurement and recording of ineffectiveness should be applied through a cumulative-effect adjustment to accumulated other comprehensive income with a corresponding entry to the opening balance of retained earnings.
  • The amended presentation and disclosure guidance is required only prospectively.
  • Certain beneficial transition elections (e.g., amending hedge documentation to indicate that subsequent hedge effectiveness assessments will be performed qualitatively; documenting the alternative “long-haul” method that will be applied if the shortcut method is determined to be inappropriate; etc.) may be made upon adoption.
  On the Horizon BDO will host a webcast on the key amendments later this fall and details will be provided in advance.  

For questions related to matters discussed above, please contact Gautam Goswami or Adam Brown.
    [1] Targeted Improvements to Accounting for Hedging Activities [2] Derivatives and Hedging

SEC Flash Report - September 2017

Wed, 09/13/2017 - 12:00am
SEC Staff Guidance Updates In August, the staff of the SEC’s Division of Corporation Finance (the Division) updated its guidance contained in a recent staff announcement, the Division’s Financial Reporting Manual (FRM),[1] and certain Compliance and Disclosure Interpretations (C&DIs) on Securities Act forms.  
 
The staff supplemented the Division’s June 29, 2017 announcement that it would make the confidential submission process (i.e., submission of a draft registration statement for nonpublic review) available to an expanded class of issuers and transactions.[2]  The supplemented announcement clarifies that:
 
  • The nonpublic review process is available for:
    • Securities Act registration statements prior to the issuer’s initial public offering date;[3]
    • Securities Act registration statements within one year of the IPO; and
    • The initial registration of a class of securities under Exchange Act Section 12(b) on Form 10, 20-F or 40-F.
  • An issuer that has publicly filed its registration statement and otherwise qualifies for the nonpublic review process may switch to the nonpublic review process for future pre-effective amendments to its registration statement (the draft amendments must subsequently be made public, the timing of which is specified in the announcement and depends on the nature of the registration and offering).
  • Issuers may submit any questions about their eligibility to use the expanded processing procedures contained in the announcement to CFDraftPolicy@sec.gov

The staff also updated its C&DIs related to the circumstances in which financial statements may be omitted from registration statements.  Whether financial statements may be omitted depends on whether (1) the registrant is an emerging growth company (EGC) or not, (2) the financial statements are annual or interim financial statements, and (3) the document is a confidential draft submission or a publicly filed registration statement. 
 
  • C&DI 101.04 now states that EGCs may omit interim financial information from draft registration statements that they reasonably believe they will not be required to present separately at the time of the offering.  Previously, EGCs were not permitted to omit interim financial statements from their filed or draft registration statements if the interim period relates to an annual period required at the time of the offering.  
 
For example, under the staff’s new policy, a calendar year-end EGC that submits a draft registration statement in November 2017 and reasonably believes that it will commence its offering in April 2018 (when annual financial information for 2017 will be required) may omit its 2015 annual financial information and the nine-month interim financial statements for 2016 and 2017 because this information will not be required at the time of the offering in April 2018.  However, if this same EGC publicly files the registration statement in January 2018, it must include the nine-month interim financial statements for 2016 and 2017 because they relate to annual periods that will be required at the time of the offering.  The staff made conforming updates to the FAST Act C&DIs to reflect this change (see Question 1).
 
  • C&DI 101.05 now states that non-EGCs may also omit interim financial statements from draft registration statements that they reasonably believe will not be required to be included at the time the registration statement is publicly filed.  Non-EGCs are not permitted to omit any interim or annual financial information at the time the registration statement is publicly filed. 
 
For example, a calendar year-end non-EGC that submits a draft registration statement in November 2017 and reasonably believes it will first publicly file in April 2018 when annual financial information for 2017 will be required may omit from its draft registration statements its 2014 annual financial information and interim financial information related to 2016 and 2017 because this information would not be required at the time of its first public filing in April 2018. 

In summary, based on the staff policies about the required financial statements in draft and publicly filed registration statements:
    Draft Registration Statements Publicly Filed Registration Statements EGCs -May omit annual and interim periods that will not be required to be presented separately at the time of the offering. -May omit annual periods that will not be required at the time of the offering.
-May not omit interim periods that relate to annual periods required at the time of the offering.  Non-EGCs -May omit annual and interim periods that will not be required to be presented separately at the time of the public filing. -May not omit annual or interim periods at the time of the public filing. 
In addition to the staff guidance above, the staff published an update to the FRM.  The inside cover of the FRM lists a summary of the paragraphs that were updated.  The update:
 
  • Adds a new section to the FRM which precedes the table of contents and describes how registrants may communicate with the Division’s Office of the Chief Accountant (CF-OCA) when requesting reporting relief under S-X Rule 3-13, answers to interpretive letter requests or informal interpretive advice, or help to explain the SEC rules, regulations, forms and guidance. 
  • Amends Section 2065 to clarify that registrants may request permission from CF-OCA to provide abbreviated financial statements in lieu of full financial statements for an acquired business that is identified as a predecessor of the registrant.  Previously, the FRM indicated that Section 2065 of the FRM did not apply if the business acquired represents the predecessor of the registrant. 
  • Conforms paragraphs 10220.1 and 10220.5 of the FRM to the C&DIs discussed above with respect to the omission of certain financial information in draft and filed registration statements.
 
For questions related to matters discussed above, please contact:   Jeff Jaramillo
National Partner
SEC Services Practice Paula Hamric
National Assurance Partner
    [1] The FRM is an internal SEC staff reference document that provides general guidance covering several SEC reporting topics. While the FRM is not authoritative, it is often a helpful source of guidance for evaluating SEC reporting issues. [2] Further details regarding the initial announcement are available in our BDO flash report. [3] The “initial public offering date” is the date of the first sale of common equity securities pursuant to an effective registration statement under the Securities Act of 1933.   

2017 BDO Board Survey

Mon, 09/11/2017 - 12:00am

Explore the 2017 BDO Board Survey:  
The responsibilities of corporate directors at publicly traded companies continue to change and grow every year. Responding to recent regulatory changes, dealing with activist shareholders, assessing the impact of new financial reporting requirements and contingency planning for long-anticipated tax reform are just a few of the issues that boards need to manage in 2017.

The BDO Board Survey, conducted annually by the Corporate Governance Practice of BDO USA, was created to act as a barometer to measure the attitudes of public company directors on these and other governance issues. The 2017 BDO Board Survey, conducted in August of 2017, examines the opinions of 130 corporate directors of public company boards.
  “The 2017 BDO Board Survey shows corporate directors are eagerly awaiting the tax reform promised by President Trump, but they seem resigned to the fact that it may not happen in 2017. They also have a high degree of confidence in their internal compliance programs, despite some widely publicized examples of businesses failing to respond to whistleblowers,” said Amy Rojik, BDO USA’s National Partner for Communications and Governance

“Directors are also focusing more fully on engaging with management in addressing major accounting changes that will be implemented over the next several years and are much more favorable towards disclosures of sustainability matters than they were a year ago.” 
Tax Reform  It has been more than 30 years since the United States signed major tax reform into law. Although there has yet to be a bill introduced providing specifics on how exactly the White House and the Republican-controlled Congress intend to achieve it, President Trump has continued to indicate tax reform is a priority in 2017. 
Public company board members are clearly rooting for such reform.

More than three-quarters (78%) of public company board members anticipate tax reform will be achieved during President Trump’s current four-year term, but just 22 percent believe it will occur in 2017. Of those predicting tax reform, an overwhelming majority (94%) anticipate that it will have a favorable impact on their business, with 20% believing the impact will be highly favorable. 



When asked the most important goal for tax reform legislation, sizable proportions of board members cite reduction of the current corporate tax rate (45%) and simplification of the tax code (37%). Smaller numbers communicated the need for tax incentives to repatriate foreign earnings (12%) or lowering the capital gains tax rate (5%).


  BDO Food for Thought

BDO explores these and other tax reform issues in a series of thought pieces and educational events designed to keep you informed as to developments that may impact your businesses. To learn more, review BDO’s 2017 BDO Tax Outlook Survey and our archived webinars: Trump, Legislation and Taxes: How the Expected Tax Reform May Impact Global Organizations and How Tax Reform Proposal Could Impact Executive Compensation. Evolving issues are further discussed in recent International Tax Alerts available here and here.

  “Corporate board members are correct in believing that tax reform, with a goal of simplicity and fairness, is achievable and, in theory, in the interests of both political parties. Unfortunately, the need to pass the 2018 budget, deal with the deadline on raising the debt ceiling and overcoming the divisions that defeated healthcare legislation will make tax reform a tall order for 2017,” said Matthew Becker, Leader of BDO USA’s National Tax Office. “If Democrats and Republicans can push aside special interests and focus on helping their constituents - not opposing each other’s ideas – tax reform can be achieved. It just may take additional time.” 
Financial Reporting Changes  The Public Company Accounting Oversight Board (PCAOB) recently approved changes to the annual auditor’s report that accompanies a business’s financial statements. One of the major changes is a requirement for the auditor’s report to discuss “critical audit matters” (CAMs) – elements of the audit, discussed with the audit committee, where the auditor had to make the most challenging, subjective or complex judgements on material matters. 

When asked their opinion of this change, close to half (48%) of corporate board members do not feel the discussion of CAMs is an improvement to the transparency and usefulness of the auditor’s report for investors. Just over one-third (36%) of the directors believe it is an improvement and 16 percent were not sure. 

Directors were evenly split (50%) on whether the discussion of CAMs in sensitive areas could make their job as a board member more difficult.


  BDO Food for Thought

Changes to U.S. auditor reporting enacted under PCAOB Audit Standard (AS) 3101 have been on the radar for quite some time and follow significant similar changes previously enacted by auditing standard-setters in the UK; Australia; and the Netherlands and now to be implemented more broadly under the International Auditing and Assurance Standards Board (IAASB) International Standards on Auditing (ISA) 701, effective for audits performed in 2017. Refer here for a comparison of the IAASB and PCAOB rule.

While PCAOB AS 3101 has staggered effective dates beginning in FY2018 and extended through FY20211, companies are strongly advised to use the current period audit cycles to dialogue with their auditors early as to what significant changes to their financial reporting may look like. The Financial Reporting Commission in the UK has recently released a report that examines the evolution of the enacted auditor reporting over the past two years that U.S. companies may reference as they prepare for the adoption of AS 3101.

 

“While Board members are not enamored with the additional disclosure and discussion of critical audit matters in the new auditor’s report, this change has been coming for a few years and we anticipate they will make this adjustment and it could lead to better auditor – client communications,” said Phillip Austin, BDO USA’s National Managing Partner for Auditing“We are working closely with our clients and engagement teams to educate and drive development of meaningful CAMs to be shared publicly should the SEC approve the PCAOB’s changes to the auditor’s report.”


With a continued drum beat of reminders by regulators as to implementation-readiness, better than three-quarters (82%) of directors indicate that their board or audit committee is actively working with management to meet historic accounting changes to revenue recognition, lease accounting and credit loss standards that are going into effect over the next few years. 

Almost as many (74%) say they are engaged with management on the need to communicate with shareholders, regulators and other stakeholders on the potential impact of these accounting changes in order to avoid potential surprises when they appear on the financial statements.

“Implementation efforts have started to accelerate lately, which may reflect board member focus on the way these new standards will impact financial statements. Communicating these changes to investors will be a key focus area moving forward,” said Adam Brown, BDO USA’s National Partner for Accounting.    BDO Food for Thought

A recent BDO alert focuses on SEC staff reminders issued to public companies with respect to SAB 74 disclosures and controls related to new accounting standards. Further, in public statements made by SEC Chief Accountant Wes Bricker,2 companies are urged to move quickly toward implementation and are reminded about the importance of disclosing the anticipated impact of adopting new accounting standards and plans for transition. Bricker, while acknowledging progress, indicated that both investors and the SEC staff “will be looking for increased disclosures throughout 2017 about the significance of the impact – whether quantitative or qualitative – of revenue recognition, among other new standards… Particularly for companies where implementation is lagging, preparers, their audit committees and auditors should discuss the reasons why and provide informative disclosures to investors about the status so that investors can assess the implications of the information.”

To aid in this effort, BDO encourages boards and their audit committees to review the Center for Audit Quality’s (CAQ) Preparing for the New Revenue Recognition Standard: A Tool for Audit Committees along with CAQ Alert No. 2017-03: SAB Topic 11.M – A Focus on Disclosures for New Accounting Standards.


Sustainability Matters  Earlier this year, President Trump withdrew the United States from the Paris Climate Accord, the global coalition meant to curb emissions that may be a causal factor of climate change. Numerous multinationals – including General Electric, Dow Chemical, Royal Dutch Shell, Exxon Mobil and Apple – were critical of the decision for numerous reasons. 

Some are trying to be responsive to shareholder demands to curb greenhouse-gas emissions, while others operate in states and countries that are putting in place climate rules and thus face pressures beyond the U.S. government. Moreover, many companies didn’t want the U.S. to cede leadership on renewable energy.

When asked about President Trump’s decision to withdraw the United States from the Paris Climate Accord, corporate directors were split, with a narrow majority (54%) indicating they were against the decision. 



On a related matter, shareholders are increasingly calling for more disclosure on businesses' sustainability efforts. In May, close to two-thirds of Exxon Mobil shareholders approved a proposal to require the company to measure and disclose how regulations to reduce greenhouse gases and new energy technologies could impact the value of its oil assets. 

Other shareholder groups have expressed similar interest in increased disclosures on sustainability matters (e.g. climate change, corporate social responsibility, etc.) and corporate directors have become increasingly receptive to the issue of providing sustainability metrics in financial statements.

In a major reversal from a year ago, a majority (54%) of board members believe that disclosures regarding sustainability matters are important to understanding a company’s business and helping investors make informed investment and voting decisions. Last year, just one-quarter (24%) of directors maintained this stance. 


  “President Trump’s decision to pull the U.S. out of the Paris Climate Accord put climate change and sustainability matters in the spotlight earlier this year. Regardless of where you stand on that decision, businesses are becoming increasingly focused on sustainability and how to incorporate it into their financial reporting,” said Christopher Tower, BDO USA’s National Managing Partner for Audit Quality and Professional Practice. “When you consider that intangible assets can account for a majority of the market value of a company, shareholders, analysts and other stakeholders need to understand ‘non-financial factors’ that are impacting a business’s value.”   BDO Food for Thought

Voluntary organizational sustainability reports continue to grow in interest and popularity globally, particularly as Directive 2014/95/EU becomes the law of the land as mandatory reporting for certain companies in Europe. Such reporting is designed to disclose information about the non-financial economic, environmental and social impacts resulting from the organization’s everyday activities. Such reports communicate the specific values and principles the organization adheres to along with its framework for governance in linking corporate strategy and commitment to a sustainable global economy and can serve as a differentiator in the marketplace.

Sustainability has also been on the SEC’s radar. In 2016, the SEC included questions regarding sustainability and public policy issues within its Concept Release related to business and financial disclosure required by Regulation S-K. With the onboarding of new SEC Chairman Jay Clayton and two new SEC commissioners still to be appointed, it remains to be seen whether sustainability will be on the new regime’s agenda aimed at protecting main street investors.


Whistleblower/Compliance Programs  The Wells Fargo fake accounts scandal and reports of widespread employee harassment at Uber and Fox News have been major news stories in 2017. In each instance, employees alleged that they communicated concerns about the problems, but their concerns were ignored.

Despite these reports of corporations failing to act when whistleblowers communicated concerns through internal compliance programs, the vast majority (93%) of board members say they receive regular reports from management, or an internal compliance executive, on whistleblower complaints and how they are being addressed. 

An almost identical percentage (92%) indicate they ask management what they are doing to communicate with employees throughout the organization about the importance of adherence to ethical standards.

The number of whistleblower tips received by the SEC in FY2016 was over 4,200 – up 40% from the FY2012 inception of the Dodd-Frank SEC Whistleblower Rules.3 The SEC logged 868 enforcement actions in FY2016 with penalties and disgorgements recorded at approximately $4 billion. Additionally since the inception of the SEC’s program, over $158 million has been awarded to whistleblowers. According to the SEC, almost 65% of award recipients were insiders of the entity on which they reported information of wrongdoing to the SEC. 

When corporate directors were asked whether the SEC’s widely publicized whistleblower bounties – enacted in 2011 – have undermined their internal whistleblower/compliance program, only a third (32%) agreed. This is a major shift from 2012 when a slight majority (51%) of the directors believed the SEC’s newly enacted bounties could undermine internal anti-fraud and compliance programs.
    “When the SEC’s whistleblower program was first introduced in 2011, there was great concern among corporate boards and compliance officers that the bounties could undermine the internal compliance programs that they had recently put in place. This year’s Board Survey demonstrates that the attitudes of corporate directors on this topic have changed considerably,” said Glenn Pomerantz, Leader of BDO USA’s Global Forensics Practice. “Board members have clearly become more comfortable with and confident in the compliance programs that they have implemented in recent years. They view the news reports of compliance failures as exceptions to the rule that can be used to educate and reinforce the benefits of strict adherence to their programs.”

  “Organizations and underlying capital markets are best served by directors who reinforce their corporate cultures by setting no tolerance expectations for ethical breaches and who demonstrate commitment to such through continual engagement with management and communication to all levels of employees,” said Jeff Jaramillo, BDO USA’s National Partner for SEC Services. “The SEC has commented extensively on this and we are heartened that directors are clearly invested in anti-fraud and compliance oversight.”   BDO Food for Thought

Even organizations with the most robust anti-fraud compliance policies and procedures are still susceptible to fraud. The SEC has encouraged directors to not only support internal whistleblowers and take all claims seriously but also to consider the favorability that could result from a company’s self-reporting of suspected fraud that is brought to its attention.4


Activist Investors 

Shareholder activism – whether through formal proxy voting or informal requests to dialogue with management - remains an emerging area of corporate governance focus. 

When asked about the rise of “activist investors” seeking to control board seats and impact corporate strategy, directors are clearly unified in their opposition to such efforts. The vast majority (95%) feel activist investors are too focused on short-term returns to secure their investments. Only five percent of board members believe that these activists are trying to unlock long-term shareholder value. 

BDO Food for Thought

Activism affects companies of all sizes and industries and is particularly relevant for small- and mid-cap companies where companies $100M-$1B (44% of total companies) accounted for approximately 60% of all activist targets in FY2016.5 Activism can help focus on and drive enhanced corporate governance. However, many worry that activist proposals may be too short-term in thought and undermine the more strategic thinking that will sustain a company and create value in the long term. At a minimum, boards need to be well-versed in shareholder perceptions of their organizations and be prepared respond to activist challenges.


Board Composition  The SEC has begun to look into existing company disclosures of the ethnic, racial and gender composition of public company boards and could make such disclosures a mandatory requirement in the future. 

Although two-thirds (66%) of directors believe their board is already proactively addressing the issue of board diversity, one-third (34%) of board members admit they are falling short in this area.


  BDO Food for Thought

Succession planning for boards should examine the evolving needs of an organization and incorporate a review of the board’s mix of skill sets, diversity of thought, and ability to act independently in the best interest of the organization. The National Association of Corporate Directors' (NACD) 2016 Blue Ribbon Commission Report Building the Strategic-Asset Board covers some key considerations in this area. BDO has further examined sound governance practices in this area during our Director Diversity – Striking the Right Balance in the Boardroom webinar.

  “Activist proposals, particularly those suggesting changes in board composition to achieve specific desired outcomes, should be viewed as an opportunity for the board to self-reflect and consider thoughtfully the needs and concerns of its shareholders while assessing how those concerns tie into the underlying objectives of the organization’s goals and strategies,” said Amy Rojik. “This, combined with timely reviews as to the adequacy of board composition through the lens of diversification and independence, can be a powerful tool for a board in carrying out its oversight responsibilities.”
BDO Board Survey These are just a few of the findings of the 2017 BDO Board Survey, conducted by the Corporate Governance Practice of BDO USA in August 2017. The annual survey examines the opinions of 130 corporate directors of public company boards regarding corporate governance and financial reporting issues. 

BDO USA’s Corporate Governance Practice is a valued business advisor to corporate boards. The firm works with a wide variety of clients, ranging from entrepreneurial businesses to multinational Fortune 500 corporations, on myriad of accounting, tax, risk management and forensic investigation issues.
Corporate Governance Practice Leaders: 
  Amy Rojik   Jay Duke   Christopher Tower   Stephanie Giammarco   Phillip Austin   Paul Heiselmann   Matthew Becker   Jeff Jaramillo   Adam Brown   Glenn Pomerantz  
1 Certain provisions – report format, auditor tenure, and other information – are effective for audits for fiscal years ending on or after 12/15/2017; while communication of CAMs for audits of large accelerated filers are effective for audits of fiscal years ending on or after 12/15/2019 and all other public companies for audits of fiscal years ending on or after 12/15/2020.

2 Refer to SEC Chief Accountant Wes Bricker’s remarks before the May 2017 Baruch College Financial Reporting Conference and additional remarks made during the December 2016 AICPA National Conference on Current SEC and PCAOB Developments.

3 Refer to the SEC’s 2016 Annual Report to Congress on the Dodd-Frank Whistleblower Program.

4 Refer to former SEC Chair Mary Jo White speech at Stanford University Rock Center for Corporate Governance 20th Annual Standard Directors’ College. 

5 Refer to Sullivan & Cromwell’s 2016 U.S. Shareholder Activism Review and Analysis that compiled proxy contests and other activist campaign data in 2016 based on an analysis of U.S. companies with a market capitalization of over $100 million.

BDO Comment Letter - PCAOB Rulemaking Docket Matter No. 044

Thu, 08/31/2017 - 12:00am
PCAOB Rulemaking Docket Matter No. 044: Proposed Amendments to Auditing Standards for Auditor's Use of the Work of Specialists

BDO is supportive of strengthening the requirements for evaluating the work of a company's employed or engaged specialist, including the application of a risk based supervisory approach to the use of specialists as the use of the work of specialists has grown and has become an essential component in many audits.
  Download

BDO Comment Letter - Proposed Accounting Standards Update

Thu, 08/31/2017 - 12:00am
Proposed Accounting Standards Update, Targeted Improvements to Related Party Guidance for Variable Interest Entities (File Reference No. 2017-240)

BDO supports certain aspects of the proposed simplifications to the VIE guidance, but recommends maintaining the current "related-party tiebreaker" test.
  Download

BDO Comment Letter - PCAOB Rulemaking Docket Matter No. 043

Thu, 08/31/2017 - 12:00am
PCAOB Rulemaking Docket Matter No. 043: Proposed Auditing Standard - Auditing Accounting Estimates, Including Fair Value Measurements, and Proposed Amendments to PCAOB Auditing Standards

BDO supports the development of a single standard that is aligned with the PCAOB's risk assessment standards and the addition of incremental guidance relating to third-party pricing services.
  Download

FASB Flash Report - July 2017

Mon, 07/31/2017 - 12:00am
FASB Simplifies Accounting for Instruments with Down Rounds  Download PDF Version 
Summary The FASB recently issued ASU 2017-11[1] to simplify the accounting for certain financial instruments with down round features. This new standard will reduce income statement volatility for many companies that issue warrants and convertible instruments containing such features. It is available here, and becomes effective for public companies in 2019 and all other entities in 2020.
Details
 

Background
A down round feature is a contractual term to protect the investor in an equity-linked instrument such as a warrant or convertible debt from declines in the issuer’s share price under certain circumstances. It results in the strike price being reduced on the basis of the pricing of future equity offerings. Down rounds are common in warrants, convertible preferred shares, and convertible debt instruments issued by private companies and development-stage public companies. Under existing GAAP, a down round feature often results in liability classification for a warrant or in bifurcation of a conversion option, which is then remeasured to fair value through earnings each period. Part I of the ASU addresses the accounting for such instruments.

 
The FASB previously issued an indefinite deferral of accounting requirements in Topic 480[2] for mandatorily redeemable financial instruments of certain nonpublic entities and certain mandatorily redeemable noncontrolling interests. This indefinite deferral resulted in a large amount of pending guidance in Topic 480, making it difficult to read. Part II of the ASU addresses this difficulty.
 

Main Provisions
Part I of the ASU changes the classification analysis of certain equity-linked financial instruments, such as warrants and embedded conversion features, such that a down round feature is disregarded when assessing whether the instrument is indexed to an entity’s own stock under Subtopic 815-40. As a result, a down round feature—by itself—no longer requires an instrument to be remeasured at fair value through earnings each period, although all other aspects of the indexation guidance under Subtopic 815-40 continue to apply.

 
For freestanding equity-classified financial instruments, the ASU requires entities that present earnings per share (EPS) to recognize the effect of the down round feature when it is triggered, i.e., when the exercise price of the related equity-linked financial instrument is adjusted downward because of the down round feature. The amount of the EPS adjustment is determined as the difference between the fair value of the instrument immediately before and after the strike price is adjusted. That amount is recorded as a dividend and as a reduction of income available to common shareholders in basic EPS. An entity may also be required to adjust its diluted EPS calculation.
 
Convertible instruments with embedded conversion options that have down round features will be accounted for under existing specialized guidance for contingent beneficial conversion features in Subtopic 470-20,[3] including the related EPS guidance.
 
The ASU does not change the accounting for liability-classified financial instruments where classification resulted from a term or feature other than a down round feature.
 
The ASU requires entities to disclose the existence of down round features in the instruments they issue, when the down round features result in a strike price adjustment, and the amount of any such adjustment.
 
Part II of the ASU recharacterizes the indefinite deferral of certain provisions of Topic 480 (currently presented as pending content in the Codification) as a scope exception. No change in practice is expected as a result of these amendments.
  Effective Date and Transition For public business entities, the amendments in Part I of the ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. For all other entities, the amendments in Part I of the ASU are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020.
 
Early adoption is permitted for all entities, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period.
 
The amendments should be applied on a full retrospective basis or on a modified retrospective basis through a cumulative adjustment to opening retained earnings in the year of initial application.
 
The amendments in Part II have no accounting impact and therefore do not have an associated effective date.
 
For questions related to matters discussed above, please contact:
  Gautam Goswami
National Assurance Partner   Liza Prossnitz
National Assurance Partner   Roscelle Gonzales
National Assurance Director         [1] (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception [2] Distinguishing Liabilities from Equity [3] Debt—Debt with Conversion and Other Options
 

Corporate Governance Flash Report - July 2017

Mon, 07/24/2017 - 12:00am
New SEC Chairman Clayton Sets Tone for the SEC’s Agenda Focused on Main Street Investors  
Download PDF Version

In his first public speech as SEC Chairman, Jay Clayton lays down guiding principles and several areas of focus for SEC action in the near-term to protect Main Street Investors with an eye toward furthering the SEC’s mission to facilitate capital formation.
  Summary On July 12, 2017, SEC Chairman Jay Clayton gave his first public speech to the Economic Club of New York, offering a look into his views on SEC policy-making and its effects on the U.S. economy. He began by laying out eight guiding principles for the SEC along with several highlighted areas where principles are to be put into practice, particularly in areas that affect “Main Street” investors – individuals within the general population who invest in the capital markets.
  Details Guiding Principles of the SEC
 
  1. “The SEC’s three-part mission is our touchstone”: To protect investors; to maintain fair, orderly, and efficient markets; and to facilitate capital formation.
 
  1. “Our analysis starts and ends with long-term interests of the Main Street investor”: Consideration of the impact SEC actions have on “Mr. and Ms. 401(k)” – are they benefitting, are there appropriate investment opportunities, do they have enough information to make investment decisions?
 
  1. “The SEC’s historic approach to regulations is sound”: There will not be wholesale changes to the three-pronged regulatory architecture – disclosure and materiality; rules applicable to market agents (e.g., exchanges, clearing agencies, broker-dealers, and investment advisors); and anti-fraud and enforcement.
 
  1. “Regulatory actions drive change, and change can have lasting effects”: Need to consider the cumulative impact that increased disclosure and regulatory burdens have on the notable reduction in the number of U.S.-listed public companies.
 
  1. “As markets evolve, so must the SEC”: While embracing disruptors of technology and innovation, the SEC must ensure its rules and operations address both the need to change and the cost that is borne by investors.
 
  1. “Effective rulemaking does not end with rule adoption”: Just as robust processes for obtaining public input and economic analysis are performed at the proposal and adoption stages, enacted rules require retrospective review to ensure they are functioning as intended.
 
  1. “The costs of a rule now often include the cost of demonstrating compliance”: Need to align the wording of and guidance for rules in recognition of the practical costs – e.g., those to be incurred by companies, third party advisors, and compliance solutions – with the vision of how the rules are intended by the SEC to be implemented.
 
  1. “Coordination is key”: The SEC must work closely with, between, and among all domestic and international organizations - two specific examples in which coordination is key include governance of over-the-counter derivatives and cybersecurity.
 
Principles to Practice
 
In putting these principles into practice, Chairman Clayton focused on five particular areas where he sees opportunities:
 
  1. Enforcement and Examinations: The SEC will continue to deploy significant resources to detect and deter fraud. Several areas highlighted in his speech include affinity fraud, microcap fraud, pump-and-dump scammers, those who prey on retirees, and sophisticated cyber thieves. Caution, however, was placed on the practice of punishing responsible companies who find themselves victims of cyber-crimes.
 
  1. Capital Formation: Chairman Clayton has been vocal about addressing the regulatory burdens cited by many private companies who opt to remain private. As a first step, earlier in July, the SEC expanded the JOBS Act approach by opening up the SEC’s Division of Corporate Finance non-public review process to IPO draft registration statements of larger domestic and non-U.S. companies beyond emerging growth companies (EGCs) with an eye to encouraging the prospect of selling shares in the U.S. public markets and doing so at an earlier stage in a company’s development. Another opportunity lies within Rule 3-13 of Regulation S-X which allows companies to request modifications to their financial reporting requirements if they feel certain disclosures are burdensome to generate and may not be material to the total information being made available to investors. 
 
  1. Market Structure: Promotion of action and review to ensure the equity market structure is optimal. This will include:
 
  1. A pilot program to test how adjustments to the access fee cap under Rule 610 of the Securities Exchange Act of 1934 would affect equities trading.
 
  1. Extension of the tenure of the SEC’s Equity Market Structure Advisory Committee (EMSAC), as the EMSAC’s charter is set to expire in August 2017.
 
  1. Creation of a Fixed Income Market Structure Advisory Committee, akin to EMSAC, to review and advise the SEC as to the efficiency and resiliency of the fixed income products market, as a more stable option for the increasing number of “Baby Boomer” retirees. 
 
  1. Investment Advice and Disclosures to Investors: Chairman Clayton is looking to specifically review the standards of conduct that investment professionals must follow in providing advice to Main Street investors. Focal points include:
 
  1. The Department of Labor (DOL) Fiduciary Rule came into effect in early June and expands the investment advice fiduciary definition under the Employee Retirement Income Security Act of 1974 (ERISA). There has been much debate and discussion about the potential impact of this rule. In June, Chairman Clayton requested public input on standards for conduct for investment advisers and broker-dealers to evaluate potential regulatory actions in light of current market activities and risk.
 
  1. Several initiatives are underway to improve access to meaningful investment information including proposed rulemaking to follow the SEC report issued November 2016 on modernizing and simplifying Regulation S-K disclosure rules.
 
  1. Resources to Educate Investors: Emphasis on leveraging technology to make a wealth of information available to investors and increase engagement with the SEC including providing resources to investors on how to conduct online background searches on investment professionals.
 
SEC Chairman Clayton’s full speech is accessible here. For more information and educational opportunities on these and other topics related to audit committee oversight, please visit BDO’s Center for Corporate Governance and Financial Reporting.
 
 
For more information, please contact one of the following practice leaders: 
  Paula Hamric   Amy Rojik   Jeff Jaramillo    

SEC Flash Report - July 2017

Mon, 07/24/2017 - 12:00am
SEC Staff Permits Delayed Adoption of ASC Topics 606 and 842 for Certain Public Business Entities  At the July 20th EITF meeting, Sagar Teotia, Deputy Chief Accountant in the Office of the Chief Accountant, announced that the SEC staff will not object if an entity that qualifies as a public business entity (PBE) solely because its financial statements or financial information is included in another entity’s filing with the SEC[1] adopts ASU No. 2014-09 – Revenue from Contracts with Customers (Topic 606) and ASU No. 2016-02 – Leases (Topic 842) using the effective dates applicable to private entities.
 
Examples of PBE financial statements or financial information that may reflect the adoption of the standards above using private company effective dates include:
 
  • Financial statements of an acquired business under S-X 3-05;
  • Financial statements of an equity method investee under S-X 3-09; and
  • Summarized financial information of an equity method investee under S-X 4-08(g). 
 
Consequently, entities meeting the criteria above may elect to adopt:
 
  • ASC Topic 606 for fiscal years beginning after December 15, 2018 and interim periods within fiscal years beginning after December 15, 2019. Previously these entities were required to adopt the standard for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.
  • ASC Topic 842 for fiscal years beginning after December 15, 2019 and interim periods within fiscal years beginning after December 15, 2020. Previously these entities were required to adopt the standard for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.
 
Such entities may still elect to adopt these standards using the public company effective dates outlined above. 
 
For questions related to matters discussed above, please contact Jeff JaramilloAdam Brown, or Paula Hamric.
    [1] Criterion (a) of the FASB Master Glossary definition of a public business entity includes other entities whose financial statements or financial information are required to be or are included in a filing with the SEC.  Further information regarding the definition of a public business entity is available here.  The announcement relates only to this type of PBE and only to the standards referenced above.  

Corporate Governance Flash Report - July 2017

Wed, 07/19/2017 - 12:00am
Reminder: SEC SAB 74 Disclosures and Controls for New Accounting Standards Download PDF Version
SEC reminds issuers:
  • To make disclosure of status of implementation of new accounting standards – with only two quarters remaining expect scrutiny of disclosures in the second and third quarter of 2017 on ASC 606 – Revenue
  • Footnote disclosure is an important aspect of adopting new GAAP – even if revenue recognition does not change on adoption, new disclosures are required
  • Controls are important and often change with new GAAP -  be prepared to demonstrate how internal control process worked to adopt new GAAP and in ongoing compliance with new GAAP
 
Summary In June 2017, the Center for Audit Quality (CAQ) released CAQ Alert No. 2017-03, SAB Topic 11.M – A Focus on Disclosures for New Accounting Standards (CAQ Alert 2017-03 or the Alert). Although CAQ Alert 2017-03 is geared toward public companies, the content may also be helpful for private companies as well.
  Details The SEC Staff Accounting Bulletin No. 74 (codified in SAB Topic 11.M), Disclosure Of The Impact That Recently Issued Accounting Standards Will Have On The Financial Statements Of The Registrant When Adopted In A Future Period (SAB 74), requires that when a recently issued accounting standard has not yet been adopted, a registrant disclose the potential effects of the future adoption in its interim and annual SEC filings. FASB Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), ASU No. 2016-02, Leases (Topic 842), and ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, all become effective over the next few years, and these new accounting standards are expected to present significant changes for many companies.
 
SAB 74 Disclosures

U.S. generally accepted accounting principles (U.S. GAAP) requires that SAB 74 disclosures should be both qualitative and quantitative. According to the Alert, the SEC staff expects that SAB 74 disclosures will become more robust and quantitative as the new accounting standard’s effective date approaches. Therefore, the following types of SAB 74 disclosures are expected in a registrant’s financial statements in the periods, before new accounting standards are effective:
 
  • A comparison of accounting policies. Registrants should compare their current accounting policies to the expected accounting policies under the new accounting standard(s).
  • Status of implementation. The status of the process should be disclosed, including significant implementation matters not yet addressed or if the process is lagging.
  • Consideration of the effect of new footnote disclosure requirements in addition to the effect on the balance sheet and income statement. A new accounting standard may not be expected to materially affect the primary financial statements; however, it may require new significant disclosures that require significant judgments.
  • Disclosure of the quantitative impact of the new accounting standard if it can be reasonably estimated.
  • Disclosure that the expected financial statement impact of the new accounting standard cannot be reasonably estimated.
  • Qualitative disclosures. When the expected financial statement impact is not yet known by a registrant, a qualitative description of the effect of the new accounting standard on the registrant’s accounting policies should be disclosed.
Internal Control Considerations
The Alert also emphasizes that registrants, their audit committees, and auditors should discuss the status of implementation of the new accounting standard(s), including changes in internal control over financial reporting (ICFR).
  Management Responsibilities
  • Determine whether appropriate internal controls are in place to minimize risk that SAB 74 disclosure are inaccurate or incomplete.
  Audit Committee Responsibilities
  • Setting the appropriate tone and establishing oversight and review processes to ensure that management is exercising appropriate judgment and that appropriate and adequate SAB 74 disclosure controls are in place and operating effectively.
  Auditor Responsibilities
  • Obtain a sufficient understanding of ICFR and respond to identified risks regarding the controls over financial statement disclosures. As part of the audit of ICFR, auditors are required to assess the design effectiveness and to test the operating effectiveness of relevant controls, which may include controls over SAB 74 disclosures.


More on Auditor Responsibilities
The Alert highlights the expectation that auditors evaluate whether adequate SAB 74 disclosures have been included in the financial statements prior to the adoption of new accounting standards and consider reviewing SAB 74 disclosures during reviews of interim financial information. After the effective date of a new accounting standard, auditors would ordinarily inquire of management about the application of new accounting standards as part of their interim reviews. PCAOB auditing standards also require the auditor to communicate to the audit committee if concerns are identified regarding management’s expected implementation of a new accounting standard. Further, in the post-effective period, auditors are required to evaluate consistency of the financial statements with U.S. GAAP, including newly adopted accounting principles.
 
The Alert also includes an appendix that includes certain relevant SEC staff speech and public comment excerpts regarding SAB 74 disclosures for consideration.
 
For more information and educational opportunities on these and other topics related to audit committee oversight, please visit BDO’s Center for Corporate Governance and Financial Reporting.
  Adam Brown   Phillip Austin   Jan Herringer   Jeff Jaramillo  

SEC Flash Report - July 2017

Tue, 07/18/2017 - 12:00am
SEC Extends Voluntary Submission of Draft Registration Statements to All Companies The SEC’s Division of Corporation Finance (the “Division”) announced on June 29, 2017 that it will make the confidential submission process (i.e. submission of draft registration statement for nonpublic review) available to an expanded class of issuers and transactions beginning July 10, 2017 as follows: 
 
Securities Act - Initial public offerings (IPOs) and initial registrations
All companies may now submit an initial registration statement confidentially, provided the Securities Act registration statement (e.g. Form S-1), as well as the initial confidential submission and all amendments, is publicly filed with the SEC no later than 15 days prior to any road show or if there is no road show, the requested effective date of the registration statement.  Prior to this new policy, the confidential submission process for IPOs was only available to emerging growth companies (EGCs) and certain foreign private issuers.
 
Exchange Act Section 12(b) - Initial registration of a class of securities
Companies may now submit a draft Exchange Act registration statement when listing a new class of securities on a national exchange (for example, for its initial listing or registration in connection with spin-offs).  Companies must publicly file the Exchange Act registration statement (e.g. Form 10) and prior confidential submissions no later than 15 days before the anticipated effective date of the registration statement.  Prior to this new policy, the confidential submission process was only available to Securities Act IPO registration statements (e.g. Form S-1).
 
Follow-on Offerings - within one year of an IPO or Exchange Act Section 12(b) registration
Registration statements for follow-on offerings within one year of an IPO or Exchange Act 12(b) registration may also be submitted for confidential review, provided the registration statement and the initial draft submission are publicly filed at least 48 hours prior to any requested effective time and date.  The confidential review is limited to the initial submission, meaning any amendments, including changes made in response to staff comments, must be done in a public filing.
 
Other important things to note on the confidential submission process:
  • The draft registration statement must be substantially complete when submitted.  However, a company that is not an EGC may omit financial information that it reasonably believes will not be required when the registration statement is initially filed publicly. This accommodation is different from the relief provided by the FAST Act, which allows an EGC to omit information it reasonably believes will not be required at the time the registration statement becomes effective.
  • Draft registration statements are “submitted” and not “filed” with the SEC and therefore do not require signatures by officers and directors and consent of auditors and other experts.  While filed public registration statements require signatures and consents, companies do not need to go back and obtain the signatures and consents for the nonpublic submissions when those submissions are filed.
  • Companies must convey their agreement with the public filing guidelines of this announcement in a cover letter to its draft registration statement.
  • Foreign Private Issuers may elect to proceed in accordance with the new policy or those available to EGCs (if the issuer qualifies as an EGC) or follow the staff guidance in its May 30, 2012 statement.
The new policy is part of the Division’s ongoing efforts to facilitate capital formation. The confidential submission program addresses concerns some companies may have about publicly disclosing sensitive or proprietary information early in the IPO process.   It also allows companies to start its IPO process away from public attention while considering other alternatives.   
 
The copy of the staff’s announcement and FAQs can be found on the SEC’s website. 
 
For questions related to matters discussed above, please contact:
  Jeff Jaramillo
National Partner
SEC Services Practice Paula Hamric
National Assurance Partner
 

Significant Accounting & Reporting Matters Q2 2017

Fri, 07/14/2017 - 12:00am
Issued on a quarterly basis, the Significant Accounting and Reporting Matters Guide provides a brief digest of final and proposed financial accounting standards as well as regulatory developments. This guide is designed to help audit committees, boards and financial executives keep up to date on the latest corporate governance and financial reporting developments.

Highlights include:
  • FASB Developments
  • SEC & PCAOB Highlights
  • IASB Projects
  • And more!
  Download

Initial Offerings Newsletter - Summer 2017

Wed, 07/12/2017 - 12:00am


U.S. IPO Market Rebounds Strongly in First Half of 2017  Download PDF Version

The U.S. market for initial public offerings (IPOs) has rebounded impressively in the first half of 2017, already surpassing 2016’s full year total for proceeds raised and reaching the midpoint of the year with a flurry of 8 IPO pricings in the final week of June - the busiest offering week of the year. 

After experiencing a major downturn last year, when potential offering companies stepped back from the IPO market amid high volatility and political uncertainty, offering activity (+88%), proceeds (+230%) and filings (+60%) are up dramatically year-over-year through the first six months of 2017. 

Moreover, offering activity appears to be building momentum, with the number of IPO pricings more than doubling from Q1 (25) to Q2 (52). *

Much of the turnaround can be attributed to a rising stock market with historically low volatility and promises of deregulation and tax reform from the new administration and Republican-controlled Congress that have combined to create a more welcoming economic climate. 

The positive performance of 2016 and 2017 IPOs – delivering double digit returns on average – has provided additional incentive to businesses considering an offering.
 

“Although the flurry of activity prior to the July 4 holiday break could be a sign that some companies are rushing to go public while there’s a window in the market, the steady growth in offerings – more than doubling from Q1 to Q2 - and the positive returns during the initial six months of 2017 could be a sign that the new-issue market is beginning a sustained rebound following the dramatic downturn of 2016,” said Christopher Tower, Partner in the Capital Markets Practice of BDO USA.   



 




  Industries
  A strength of the current U.S. IPO market is the wide breadth of industries represented among the offerings companies during the first half of 2017. The healthcare and technology sectors have been the leaders in offerings, but numerous other industries – energy, financial, industrial, real estate and consumer - have generated several offerings in 2017. 
  A market that enjoys broad strength in multiple industries is healthier and less likely to falter. Below is a breakdown of 2017 IPOs by sector:
 

Forecast  Although this year’s dramatic year-over-year jump in offerings, proceeds and filings is partially attributable to the depths the market reached in 2016, the momentum in pricing activity and the increased deal size has offerings and proceeds on pace to exceed the annual averages for offerings (149) and proceeds ($40.2 billion) for the past decade. 
  With market indices near all-time highs, continued low volatility and shares of newly public companies performing well, the IPO forecast for the remainder of 2017 looks bright as capital markets are largely receptive to offerings from a wide breadth of industries. Absent an unforeseen shock to the market, the pace of offerings should continue to accelerate during the second half of the year.
  At the close of Q2, the Securities and Exchange Commission announced an additional incentive to boost the number of businesses going public. Beginning July 10, all companies considering an initial public offering will be able to file their registration statements confidentially with the SEC until 15 days prior to the commencement of their roadshow, when offering businesses meet with prospective investors. 
  This is an extension of a provision of the 2012 JOBS Act that was designed to encourage companies with less than $1 billion in annual revenues to go public. The provision allows companies considering an offering to keep their financing intentions, business strategy and operating performance private while the SEC reviews their prospectus, thereby providing them with more flexibility about when to go public and more time to work out any regulatory kinks.
“The SEC’s move to extend the JOBS Act’s confidential filing provision to all offering companies appears to be the latest attempt by regulators to address a decline in U.S. IPOs. While this is certainly a welcome move to encourage more potential offerings, it also limits the time investors have to study the offering prospectus,” said Jeff Jaramillo, SEC Practice Leader for BDO USA. “The continued wide availability of private financing and the very active mergers and acquisitions market will remain major obstacles to growing the ranks of publicly traded businesses.”

While the IPO forecast for 2017 is very promising right now, the outlook can change swiftly in the very connected world we live in. Surprising political outcomes and deadly terrorist attacks in various countries during the past year have demonstrated how international news can swiftly impact U.S. markets and introduce a level of volatility that is not conducive for businesses considering a public offering.

“Despite offerings and proceeds demonstrating strong growth in 2017, the IPO market will remain well below its most recent high-water mark of 2014 when it raised more than $85 billion in proceeds,” said Ted Vaughan, Partner in the Capital Markets Practice of BDO USA. “Some of the most high-profile startups are still staying away from the public market, reflecting concerns about whether they can match the rich valuations placed on them by private investors. Thus far, the uneven performance of the Snap IPO has reinforced those concerns. Until these fears are allayed, don’t expect to see Uber, Airbnb and some of the other high-profile “unicorns” coming to market in the near term.” 
 
For more information on BDO’s Capital Markets services, please contact one of the regional leaders:
  Jeff Jaramillo
Washington, D.C.   Christopher Tower
Orange County   Lee Duran
San Diego   Ted Vaughan
Dallas   Paula Hamric
Chicago    

Initial Offerings Newsletter - Summer 2017

Wed, 07/12/2017 - 12:00am


U.S. IPO Market Rebounds Strongly in First Half of 2017  Download PDF Version

The U.S. market for initial public offerings (IPOs) has rebounded impressively in the first half of 2017, already surpassing 2016’s full year total for proceeds raised and reaching the midpoint of the year with a flurry of 8 IPO pricings in the final week of June - the busiest offering week of the year. 

After experiencing a major downturn last year, when potential offering companies stepped back from the IPO market amid high volatility and political uncertainty, offering activity (+88%), proceeds (+230%) and filings (+60%) are up dramatically year-over-year through the first six months of 2017. 

Moreover, offering activity appears to be building momentum, with the number of IPO pricings more than doubling from Q1 (25) to Q2 (52). *

Much of the turnaround can be attributed to a rising stock market with historically low volatility and promises of deregulation and tax reform from the new administration and Republican-controlled Congress that have combined to create a more welcoming economic climate. 

The positive performance of 2016 and 2017 IPOs – delivering double digit returns on average – has provided additional incentive to businesses considering an offering.
 

“Although the flurry of activity prior to the July 4 holiday break could be a sign that some companies are rushing to go public while there’s a window in the market, the steady growth in offerings – more than doubling from Q1 to Q2 - and the positive returns during the initial six months of 2017 could be a sign that the new-issue market is beginning a sustained rebound following the dramatic downturn of 2016,” said Christopher Tower, Partner in the Capital Markets Practice of BDO USA.   



 




  Industries
  A strength of the current U.S. IPO market is the wide breadth of industries represented among the offerings companies during the first half of 2017. The healthcare and technology sectors have been the leaders in offerings, but numerous other industries – energy, financial, industrial, real estate and consumer - have generated several offerings in 2017. 
  A market that enjoys broad strength in multiple industries is healthier and less likely to falter. Below is a breakdown of 2017 IPOs by sector:
 

Forecast  Although this year’s dramatic year-over-year jump in offerings, proceeds and filings is partially attributable to the depths the market reached in 2016, the momentum in pricing activity and the increased deal size has offerings and proceeds on pace to exceed the annual averages for offerings (149) and proceeds ($40.2 billion) for the past decade. 
  With market indices near all-time highs, continued low volatility and shares of newly public companies performing well, the IPO forecast for the remainder of 2017 looks bright as capital markets are largely receptive to offerings from a wide breadth of industries. Absent an unforeseen shock to the market, the pace of offerings should continue to accelerate during the second half of the year.
  At the close of Q2, the Securities and Exchange Commission announced an additional incentive to boost the number of businesses going public. Beginning July 10, all companies considering an initial public offering will be able to file their registration statements confidentially with the SEC until 15 days prior to the commencement of their roadshow, when offering businesses meet with prospective investors. 
  This is an extension of a provision of the 2012 JOBS Act that was designed to encourage companies with less than $1 billion in annual revenues to go public. The provision allows companies considering an offering to keep their financing intentions, business strategy and operating performance private while the SEC reviews their prospectus, thereby providing them with more flexibility about when to go public and more time to work out any regulatory kinks.
“The SEC’s move to extend the JOBS Act’s confidential filing provision to all offering companies appears to be the latest attempt by regulators to address a decline in U.S. IPOs. While this is certainly a welcome move to encourage more potential offerings, it also limits the time investors have to study the offering prospectus,” said Jeff Jaramillo, SEC Practice Leader for BDO USA. “The continued wide availability of private financing and the very active mergers and acquisitions market will remain major obstacles to growing the ranks of publicly traded businesses.”

While the IPO forecast for 2017 is very promising right now, the outlook can change swiftly in the very connected world we live in. Surprising political outcomes and deadly terrorist attacks in various countries during the past year have demonstrated how international news can swiftly impact U.S. markets and introduce a level of volatility that is not conducive for businesses considering a public offering.

“Despite offerings and proceeds demonstrating strong growth in 2017, the IPO market will remain well below its most recent high-water mark of 2014 when it raised more than $85 billion in proceeds,” said Ted Vaughan, Partner in the Capital Markets Practice of BDO USA. “Some of the most high-profile startups are still staying away from the public market, reflecting concerns about whether they can match the rich valuations placed on them by private investors. Thus far, the uneven performance of the Snap IPO has reinforced those concerns. Until these fears are allayed, don’t expect to see Uber, Airbnb and some of the other high-profile “unicorns” coming to market in the near term.” 
 
For more information on BDO’s Capital Markets services, please contact one of the regional leaders:
  Jeff Jaramillo
Washington, D.C.   Christopher Tower
Orange County   Lee Duran
San Diego   Ted Vaughan
Dallas   Paula Hamric
Chicago    

BDO Comment Letter - Government Auditing Standards, 2017 Exposure Draft

Wed, 07/12/2017 - 12:00am
Government Auditing Standards, 2017 Exposure Draft

BDO supports the GAO's efforts to update the Government Auditing Standards (Yellow Book) to reflect the major developments in the auditing, accountability, and financial management professions.
  Download

BDO Knows: FASB - June 2017

Thu, 06/29/2017 - 12:00am


On May 28, 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (ASC 606), which provided new guidance for recognizing revenue for contracts with customers and is poised to change the way restaurant franchisors recognize their revenue.  

Under current revenue guidance, a franchisor would recognize the revenue from the initial franchise fee upon evidence of completion of all initial obligations (e.g., training, site selection). Generally, the opening of the store was the best indication that these obligations had been satisfied. The royalty, of course, is recognized as the restaurant's sales took place over the period the restaurant's operation.

However, ASC 606 indicates that the franchise right is a distinct performance obligation that transfers over time and, therefore, any portion of the initial franchise fee that is allocated to the franchise right should be recognized over the course of the contract term. This conclusion results from the fact that the franchise license derives its value from the past and ongoing activities of the franchisor, such as branding and marketing activities. There is no change to accounting for the royalty fees; they will continue to be recognized as the related sales occur.

Although in most cases the upfront franchise fee (and, by extension, any area development fees) will now generally be recognized over the term of the franchise license, the new standard retains the requirement to defer any broker fees paid in relation to entering into the franchise license, and requires them to be amortized generally over the same period.  

For a more in-depth understanding of the new standard and the impacts it will have on restaurant franchisors, franchisees and owners/operators, download our newsletter below.
Download Newsletter
 
For questions related to matters discussed above, please contact: 
  Angela Newell
National Assurance Partner   Jay Duke 
Managing Partner and Leader of BDO's National Franchise Practice    Dustin Minton 
Assurance Partner and Co-Leader of BDO's National Restaurant Practice   Alan Stevens 
Assurance Partner

Corporate Governance Flash Report - June 2017

Fri, 06/16/2017 - 12:00am
PCAOB Adopts New Standard to Enhance the Auditor’s Report; Proposes New Standard Regarding Auditing Accounting Estimates; and Proposes Amendments Regarding Auditor’s Use of Specialists


Download PDF Version


Summary On June 1, 2017 the Public Company Accounting Oversight Board (PCAOB) adopted a new auditor reporting standard, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, and related amendments to certain other PCAOB standards, to enhance the auditor’s report by requiring communication of additional information about the audit, including communication of critical audit matters.
 
The PCAOB also proposed for public comment a new auditing standard, Auditing Accounting Estimates, Including Fair Value Measurements, along with related amendments, to enhance the requirements applicable to auditing accounting estimates, including fair value measurements. In addition, the PCAOB proposed amendments to strengthen requirements regarding when auditors use the work of specialists in an audit.
 
The following summarizes the requirements included within the adopted standard, as well as the proposed standard and the proposed amendments.
Details Adopted AS 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, and Related Amendments  

The new standard and related amendments retain the pass/fail opinion in the existing auditor’s report, but significantly changes the existing auditor’s report through the following requirements:
 
  • The new standard requires the auditor to communicate in the auditor’s report any critical audit matters (CAMs) arising from the audit, or state that the auditor determined that there were no CAMs. CAMs are matters that were communicated or required to be communicated to the audit committee, and that (1) relate to accounts or disclosures that are material to the financial statements, and (2) involve especially challenging, subjective, or complex auditor judgment.
  • The auditor’s report will include disclosure of the auditor’s tenure, i.e., the year in which the auditor began serving consecutively as the company’s auditor.
  • The auditor’s report will also include a statement that the auditor is required to be independent.
  • The phrase, “whether due to error or fraud,” will be included in the auditor’s report in describing the auditor’s responsibility under PCAOB standards to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements.
  • The opinion will appear in the first section of the auditor’s report, and section titles will be added to the report.
  • The auditor’s report will be addressed to the company’s shareholders and board of directors or equivalents (additional addressees are also permitted).
 
The communication of each CAM in the auditor’s report will include:
  • identification of the CAM;
  • a description of the principal considerations that led the auditor to determine that the matter was a CAM;
  • a description of how the CAM was addressed during the audit; and
  • a reference to the applicable financial statement accounts or disclosures.
 

Source: Adapted from PCAOB Release No. 2017-001
  Observations Source of CAMs: The source of CAMs will be drawn from matters required to be communicated to the audit committee, even if not actually communicated, and matters actually communicated (even if not required). As such, the first filter used to determine the population of possible CAMs recognizes the audit committee’s oversight of the audit, such that the CAMs are to be drawn from matters communicated or required to be communicated to the audit committee. The second filter to be applied considers whether the accounts or disclosures are material to the financial statements or involve especially challenging, subjective or complex auditor judgment.
 
Materiality: The materiality component of the definition of CAMs pertains to accounts or disclosures that are material to the financial statements.  The PCAOB concluded that the concept of materiality was essential to ensure the CAMs communicated were appropriately balanced such that the need to make the auditor’s report more informative and useful for investors was not overshadowed by the inclusion of numerous immaterial matters that could cloud the importance of those items deemed to enhance the communicative value of the auditor’s report.  
 
"Relates to" clarifies that the CAM could be an element of an account or disclosure and does not necessarily need to correspond to the entire account or disclosure in the financial statements. The standard includes several examples of how this might apply:
  • The auditor's evaluation of the company's goodwill impairment assessment could be a CAM if goodwill was material to the financial statements, even if there was no impairment; it would relate to goodwill recorded on the balance sheet and the disclosure in the notes to the financial statements about the company's impairment policy and goodwill.
  • A CAM may not necessarily relate to a single account or disclosure but could have a pervasive effect on the financial statements or relate to many accounts or disclosures. E.g., the auditor's evaluation of the company's ability to continue as a going concern could also represent a CAM depending on the circumstances of a particular audit.
  • A matter that does not relate to accounts or disclosures that are material to the financial statements cannot be a CAM. E.g., a potential loss contingency that was communicated to the audit committee, but that was determined to be remote and was not recorded in the financial statements or otherwise disclosed would not meet the definition of a CAM. Similarly, the determination that there is a significant deficiency (SD) in ICFR, in and of itself, cannot be a CAM. However, a SD could be among the principal considerations that led the auditor to determine that a matter is a CAM. The final standard indicates that while the auditor is required to describe the principle considerations that led the auditor to determine that the matter is a CAM and how the overall matter was addressed, it is not necessary for the auditor’s description to use terminology from other auditing standards, such as “significant deficiency” within the broader context of a CAM.
 
CAM Determination: The determination of CAMs remains principles-based and the final standard does not specify any items that would always constitute CAMs. For example, all matters determined to be “significant risks” under PCAOB standards may not be determined to be CAMs. The auditor must determine, in the context of the specific audit, that a matter involved especially “challenging, subjective, or complex auditor judgment.” Refer to factors outlined in Figure 1.
 
The final standard requires the auditor to communicate CAMs arising for only the current audit period, though the auditor would not be precluded from including CAMs for prior periods. The PCAOB indicates that it would expect that in most audits the auditor will determine that at least one matter would be considered a CAM. However, there may be circumstances whereby the auditor determines there are no CAMs to disclose in the current period. In this case, a statement to that effect must be included within the auditor’s report.
 
Disclosure of How CAMs Were Addressed in the Audit: The final standard includes required introductory language to include within the auditor’s opinion to refer to the communication of CAMs. Furthermore, the final standard does not prescribe an approach for the how an auditor is to describe within the auditor’s report how the CAMs were addressed during the audit. This approach was meant to provide flexibility in how CAMs may be addressed by the auditor, bearing in mind the purpose of a CAM is to provide information about the audit of the company’s financial statements that will be useful to investors and other stakeholders. In communicating CAMs, the auditor is not to imply that he/she is providing a separate opinion on them or on the accounts or disclosures to which they relate. It is also not appropriate for the auditor to use language that could call into question his/her opinion on the financial statements, taken as a whole. Additionally, when describing CAMs, the auditor is not expected to provide information about the company that has not been made publicly available by the company unless such information is necessary to describe the principal considerations that led the auditor to determine that a matter is a CAM or how the matter was addressed in the audit.
 
The standard indicates that the amount of documentation required in the auditor’s report could vary significantly from audit to audit based on the circumstances specific to the audit. The auditor will further be required to provide a draft of the auditor’s report to and discuss it with the audit committee prior to release of the auditor’s report. 
 
Auditor Tenure: Rather than including auditor tenure in the new PCAOB Form AP, the PCAOB is requiring auditors to include such information within the auditor’s report since it is the primary vehicle by which the auditor communicates with investors. Inclusion of auditor tenure within the auditor’s report is meant to provide investors with timely and readily available information. In response to concerns by commenters that communication of auditor tenure is more appropriately made as a form of a company disclosure, and should not be included within the auditor’s report, the PCAOB acknowledged that the SEC may in the future determine that auditor tenure should be disclosed elsewhere in addition to or instead of in the auditor’s report and at that time the PCAOB would work with the SEC to appropriately coordinate requirements.
   Effective Date and Applicability The PCAOB adopted a phased approach to effectiveness for the new standard and amendments, to provide accounting firms, companies, and audit committees more time to prepare for implementation of the CAM requirements, which are expected to require more effort to implement than the other improvements to the auditor’s report. Subject to approval by the SEC, the final standard and amendments will take effect as follows:
  New Auditor Reporting Provisions
  Effective Date Report format, tenure, and other information
  Audits for fiscal years ending on or after December 15, 2017
  Communication of CAMs for audits of large accelerated filers
  Audits for fiscal years ending on or after June 30, 2019
  Communication of CAMs for audits of all other companies
  Audits for fiscal years ending on or after December 15, 2020
   
The adopted standard generally applies to audits conducted under PCAOB standards; however, communication of CAMs is not required for audits of emerging growth companies; brokers and dealers; investment companies other than business development companies; and employee stock purchase, savings, and similar plans. Auditors of these entities may choose to voluntarily include CAMs in the audit report. However, the other requirements of the final standard will apply to these audits.
 
The PCAOB Release adopting AS 3101 and related amendments can be accessed here.
 
Additionally, the PCAOB has developed a fact sheet on the adopted standard, which may be helpful in understanding the main provisions of the standard, accessible here.

Proposed AS 2501, Auditing Accounting Estimates, Including Fair Value Measurements, and Related Amendments  

This proposed standard replaces three existing auditing standards: AS 2501, Auditing Accounting Estimates, AS 2502, Auditing Fair Value Measurements and Disclosures, and AS 2503, Auditing Derivative Instruments, Hedging Activities, and Investments in Securities. The proposed single standard also includes a special topics appendix that addresses auditing the fair value of financial instruments, including the use of information from pricing services.
 
The proposed single standard would strengthen existing requirements by:
  • Prompting auditors to devote more attention to addressing potential management bias in accounting estimates, while emphasizing the importance of professional skepticism;
  • Extending certain key requirements in the extant standard on auditing fair value measurements to all accounting estimates in significant accounts and disclosures, to reflect a uniform approach to substantive testing;
  • Prompting auditors to focus on estimates with a greater risk of material misstatement;
  • Providing specific requirements to address certain unique aspects of auditing fair values of financial instruments, including the use of pricing sources (e.g., pricing services and brokers or dealers); and
  • Updating other requirements for auditing accounting estimates to provide clarity and specificity

The proposed standard can be accessed here and a fact sheet that summarizes the main provisions of the proposed standard can be accessed here.
 
Comments regarding the proposed standard and related amendments to other PCAOB standards are due August 30, 2017 and may be submitted via the PCAOB’s website, as indicated in the proposal document.

Proposed Amendments to Auditing Standards for Auditor’s Use of the Work of Specialists
 
These proposed amendments apply a risk-based supervisory approach to both auditor-employed and auditor-engaged specialists, as well as strengthen requirements for evaluating the work of a company’s specialist. Under this proposal, the PCAOB amends two extant standards: AS 1105, Audit Evidence, and AS 1201, Supervision of the Audit Engagement. AS 1105 would be amended to add a new appendix that addresses using the work of a company’s specialist as audit evidence, based on the risk-based approach of the risk assessment standards. AS 1201 would be amended to add a new appendix on supervising the work of auditor-employed specialists. The proposal also would replace extant AS 1210, Using the Work of a Specialist, and retitle it to Using the Work of an Auditor-Engaged Specialist, to set forth requirements for using the work of auditor-engaged specialists.  
 
The proposed amendments can be accessed here and a fact sheet that summarizes the main provisions of the proposed amendments can be accessed here.
 
Comments regarding the proposed amendments to other PCAOB standards are due August 30, 2017 and may be submitted via the PCAOB’s website, as indicated in the proposal document.
  Conclusion and Next Steps We encourage you to review the PCAOB publications cited above and engage your auditors in conversation about the PCAOB’s new standard and its other proposals. BDO will be announcing and offering related learning opportunities to our clients and contacts. For further insights and resources, refer to BDO’s Center for Corporate Governance and Financial Reporting
 
For questions related to matters discussed above, please contact: 
  Jan Herringer
National Assurance Partner   Patricia Bottomly
National Assurance Partner

EBP Commentator - Spring 2017

Fri, 06/16/2017 - 12:00am



Download PDF Version
Utilizing Data Analytics for Employee Benefit Plans  Contributed by Kirstie Tiernan
 
Data Analytics. The phrase brings to mind words like Big Data, Business intelligence, Analyze, Predictive Models, and Visualize. In this article, Kirstie Tiernan, a Forensic Technology Services Director with BDO’s Consulting Group, introduces the concept of using data analytics (commonly defined as the use of techniques and processes to extract, categorize and analyze data) as a tool for plan sponsors and discusses some of the key considerations that are the building blocks to understanding and using data analytics successfully.
 
The applications of data analytics to employee benefit plans (EBPs) are potentially endless. Imagine a large participant population with manual data entry of 401(k) deferrals that are performed by many payroll analysts. To internally test that the deferrals were input correctly, you could run a comparison of the data set of deferral changes (from the record-keeper) to the payroll data. As those familiar with administering plans know, EBPs can be prone to operational errors, which must be corrected by the sponsor. Finding these errors timely can reduce the sponsor’s cost of correction.
 
There is often a significant gap between the possibilities of what can be done with data and what a plan sponsor can realistically execute. Limitations on resources, time, budget, and software are all common factors that keep companies from taking full advantage of data analytics. Important keys to using data analytics include: start small, identify projects with clearly attainable objectives (to help obtain “buy-in” from others within the company), and build an environment that makes it easy to progressively add in additional datasets and analytics.
 
What Data Do You Have?
One of the first things to consider is what data is available. A company may have a human resources information system, payroll system, time and expenses system, email, social media datasets, etc. that hosts data pertaining to the employee benefit plan. Depending on the nature of the desired analytics, public records, market intelligence, industry benchmarking data, Twitter feeds, and general online chatter may also be relevant. It is important to map out the available data sources and to understand both the “owners” of the data and access to each dataset. An assessment of what is available and the effort needed to obtain the data on a regular basis is crucial to planning an effective analytics strategy.
 
What Tools Do You Have (Or Need)?
Does the company already use certain tools that plan management could utilize throughout the analytics program? SQL Server and Oracle are large database tools that most companies have in place behind their ERP systems. Other tools that are used often include statistical tools like R or SAS or analysis tools like IDEA or ACL. Visualization is also a very important consideration because it doesn’t matter how much work is done if it can’t be explained simply and succinctly. Tableau, Qlik, and MicroStrategy are some of the more popular tools out there for visualization and are generally considered fairly easy to use. Of course, Excel charts are also a basic (albeit minimum) option. For companies with access to programmers and developers, we typically recommend using SQL Server and Tableau, which are a good combination of analysis tools. If no developer resources are available, ACL/IDEA/Excel can be used.
 
What Data Do You Need To Analyze?
The crucial question with analytics is what story to tell. The easiest place to start is with the most manual set of tasks. Identify what manual tasks are performed by the plan sponsor. Rather than spending the time manually pulling data and then extracting, updating, combining, formatting, and charting it, consider using an analytic that will pull the data together from multiple systems and also target and focus the analysis so that the review of false positives is limited.
 
One caution with the incorporation of analytics is to be careful so as not to add unnecessarily to the workload. Incorporating several reports for the plan committee or the plan auditor to consider by using analytics is only beneficial if it reduces the work elsewhere or provides such an additional value to the review that it is worth the additional time and effort. For example, we assisted a plan sponsor who had incorrectly calculated 401(k) contributions which resulted in the need to go back and review all 401(k) contribution requests. The majority of these requests were handled in emails back and forth with the human resources department. The plan sponsor provided several Outlook email files that were processed through a document management tool using search term reports which reduced the potential universe of approximately 46,000 emails to approximately 6,000 emails. Utilizing email threading to review only the strings of emails that were non-duplicated, the number of emails to be reviewed was further decreased to 3,000. The remaining emails were reviewed for the pertinent information. By running the search terms and email threading, the desired information was obtained while only reviewing 6.8% of the total document universe.
 
How Do You Ensure the Data Analysis Process Adds Value?
Before going through the steps of pulling together data, running the analytics, and automating a process, a suggested first step is to think about how the analytic can be modified to drive value and consider the primary intended goal(s) of the process. For example, before analyzing participant accounts for anomalies, consider what potential issues can be identified and corrected. Likewise, identifying plan vendors with weekend payments may be an interesting exercise, but flagging vendors with duplicate payments where funds could be recovered would be a goal that adds real value.
 
We also often use analytics during our forensic investigations by identifying patterns and trends across years and systems of data. One particular investigation related to a potential fraud in a defined benefit plan. Using visualizations made it much easier to see that one employee received significantly higher payments over years of time compared to the payment activity of other participants. Benefit payments were broken down between type, such as beneficiary, lump sum, and retirement annuity payments. Using these categories, paired with the employees’ years of service, spotlighted unusual activity based on averages. While these visual charts did not identify fraud, they summarized the data in a way where we could focus our interviews and forensic review in an efficient manner. This example also highlights that, while analytics may not always provide a clear-cut answer, it can be an effective tool to focus and drive the right questions.
 
AICPA ASB Proposes Standard on Auditor Reporting on ERISA Financial Statements Contributed by Darlene Bayardo
 
In an effort to improve the communicative value and relevance of the auditor’s report, the AICPA’s Auditing Standards Board (ASB) has issued the exposure draft, Proposed Statement on Auditing Standards (SAS), Forming an Opinion and Reporting on Financial Statements of Employee Benefit Plans Subject to ERISA (Exposure Draft).
 
The Exposure Draft would considerably transform the way EBP audits are performed and reported. Significant proposed changes include, but are not limited to, the following:
  • Procedures to be performed for specific plan provisions relating to financial statements areas, irrespective of the risk of material misstatement
  • Requirement to report findings from procedures performed on specific plan provisions relating to the financial statements (either included in the auditor’s report on the ERISA plan financial statements or issued as a separate report), other than when clearly inconsequential
  • Incremental requirements regarding the engagement acceptance and written representations
  • Additional procedures and considerations relating to the Form 5500 filing (as the auditor’s report is attached to such filing)
  • Proposed new reporting model for audits of ERISA plans that, among other things, changes the form and content of the auditor’s report when management imposes a limitation on the scope of the audit, as permitted by ERISA (limited scope audit)
  • Changes to the form and content of the auditor’s report for an unmodified opinion
  • Expanded descriptions of management’s responsibilities
  • Expanded reporting on the ERISA supplemental schedules
  • Required emphasis-of-matter paragraphs
 
The proposed SAS would be codified as AU-C section 703 in AICPA Professional Standards and would apply to audits of single employer, multiple employer, and multiemployer plans subject to ERISA. It would be effective for audits of financial statements for periods ending on or after December 15, 2018.
 
It is highly recommended that plan sponsors, service providers and auditors provide comments directly to the ASB. The ASB identified 9 specific issues within the Exposure Draft in which feedback is requested. Comments are most helpful when they refer to specific paragraphs in the Exposure Draft, include reasons for the comments, and where appropriate, make specific suggestions for any proposed changes. It is also helpful to provide comments on areas in which the respondent is in agreement with the proposals. The comment deadline is August 21, 2017.
 
The Exposure Draft is available here.
 
FASB Updates Presentation of Employee Benefit Plan Interest in a Master Trust Contributed by Darlene Bayardo 
 
ASU 2017-06, Employee Benefit Plan Master Trust Reporting, amends the presentation and disclosure requirements for an EBP interest in a master trust. The amendments apply to EBPs within the scope of Accounting Standards Codification (ASC) 960, Plan Accounting – Defined Benefit Pensions Plans, ASC 962, Plan Accounting – Defined Contribution Pension Plans, and ASC 965, Plan Accounting – Health and Welfare Benefit Plans.
 
A master trust is a trust for which a regulated financial institution (i.e., a bank, trust company, or similar financial institution that is regulated, supervised, and subject to periodic examination by a state or federal agency) serves as a trustee or custodian and in which assets of more than one EBP sponsored by a single employer or by a group of employers under common control are held. Under the ASU:
 
  • An EBP with an interest in a master trust will be required to present its interest in the master trust and the change in its interest in that master trust as single line items in the statement of net assets available for benefits and the statement of changes in net assets available for benefits, respectively.
  • An EBP with an undivided (proportionate) interest in a master trust will continue to disclose its percentage interest in the master trust.
  • An EBP with a divided interest in a master trust will disclose the dollar amount of its interest in specific investments held by the master trust, rather than its percentage interest in the master trust itself.
  • An EBP will also disclose a master trust’s other asset and liability balances and the dollar amount of the plan’s interest in each of those balances.
  • Health and welfare plans’ investment disclosures for 401(h) account assets have been eliminated. Instead, the plan financials will disclose the name of the defined benefit pension plan which includes such investment disclosures.
 
The amendments in ASU 2017-06 are effective for fiscal years beginning after December 15, 2018, and should be applied retrospectively. Early adoption is permitted.
 
Updates to Retirement Plan Correction Procedures Contributed by Kimberly Flett 
 
The Internal Revenue Service (IRS) released Revenue Procedure (Rev. Proc.) 2016-51 updates to the Employee Plans Compliance Resolution System (EPCRS) in September 2016 replacing Rev. Proc. 2013-12. While the Rev. Proc. makes small, clarifying updates, it does not significantly change EPCRS’s substantive provisions. It incorporates changes described in Rev. Proc. 2015-27 and Rev. Proc. 2015-28. A summary of the key changes include:
 
  • Under Rev. Proc. 2016-37 the requirement to submit a determination letter application when correcting qualification failures that includes a plan amendment no longer applies.
  • Fees associated with the Voluntary Correction Program (VCP) are now considered user fees and are no longer detailed in the EPCRS revenue procedure. For VCP submissions made after 2016, refer to the annual Employee Plans user fees noted in Rev. Proc. 2017-4 to determine the current VCP user fees.
  • The availability of the IRS Self-Correction Program (SCP) for significant failures has been modified to provide that, for qualified individually designed plans, a determination letter need not be current to satisfy the Favorable Letter requirement.
  • Under the IRS Audit Closing Agreement Program (Audit CAP), a reasonable sanction is no longer a negotiated percentage of the maximum payment amount (MPA). Instead, the sanction will be based on a review of the specific facts and circumstances; the MPA amount is now just one of the factors to be considered. Generally, the sanctions will not be less than the fees associated with VCP. The IRS has a new approach to determining applicable sanctions for any late amender failures discovered during an IRS review of a determination letter application.
 
The Rev. Proc. was effective January 1, 2017; the provisions could not be applied by plan sponsors before that date.
 
Use of Forfeitures in Safe Harbor 401(k) and 403(b) Plans Contributed by Kimberly Flett 
 
In January 2017, the IRS issued a proposed regulation under which forfeitures may now be utilized to fund Qualified Non-Elective Contributions (QNECs) and Qualified Matching Contributions (QMACs), including ADP safe harbor matching and non-elective contributions (fully vested sources) at the time the amounts are funded[1]. Previously, forfeiture amounts could only be applied to sources of funding subject to a vesting schedule, such as matching and/or profit sharing contributions. Additionally, certain pre-approved plan documents included language prohibiting the use of forfeitures to fund safe harbor contributions. The limitations imposed by the funding source requirements and plan document stipulations created administrative challenges for plan sponsors attempting to appropriately apply forfeitures to select funding sources. The proposed regulation significantly impacts the use of forfeitures for safe harbor 401(k) plans and 403(b) plans and is anticipated to be a help to administrators of 403(b) plans that utilize fully-vested funding options since the proposed regulation will provide more viable funding options.
 
Even though the regulation is proposed, it may be relied upon. While this does not permit a retroactive application to the 2016 plan year, forfeitures may be applied to current 2017 funding, such as matching contributions.
 
Substantiation of Hardship Distributions Contributed by Mary Espinosa 
 
The IRS recently issued two memorandums to its employee plan examiners indicating it is permissible for 401(k) and 403(b) plan sponsors and their service providers to rely on participants’ written summaries describing their financial hardships when processing hardship withdrawals from plans that apply safe harbor event rules.
 
A hardship distribution must be made on account of an immediate and heavy financial need of the employee and the amount must be necessary to satisfy the financial need. Types of hardship distributions that generally fall under the safe-harbor standards include unpaid medical expenses, purchase of a primary residence, payment of tuition, payments necessary to prevent eviction, funeral expenses, and certain expenses to repair damage to the primary residence. Substantiation that a requested hardship distribution is for one of the above reasons is required to determine that the distribution is based on an immediate and heavy financial need.
 
The IRS memorandums allow plans that apply the safe harbor standards’ rules to rely on a participant-provided summary of the financial hardship, provided that certain information is included in the summary. The plan sponsor or service provider must provide the participant with a notification containing certain information about the distribution. If certain requirements are met, the plan sponsor does not need to obtain source documents from the participant, on the condition that the participant agrees to retain and provide source documents upon request. If the distribution process is outsourced to a service provider, then the service provider will provide the plan sponsor, at least annually, a summary of the hardship withdrawals during the year or provide access to the summary information.
 
These memorandums are expected to assist plan administrators by providing insight and guidance as to what an IRS examiner may request upon audit and therefore what information should be obtained and maintained related to hardship withdrawals. As a best practice, we recommend plan sponsors review the plan’s controls and procedures surrounding hardship distributions. The sponsors should also verify whether hardship distributions are permissible under the plan document and discuss with service providers the roles and responsibilities of each party in the hardship distribution process, including providing the required notifications to participants.  
Our EBP Center of Excellence is dedicated to assisting plan sponsors in addressing their various EBP needs. For more information on BDO’s EBP services, please contact a member of our practice leadership:
  Beth Lee Garner
National Practice Leader      Luanne MacNicol, Grand Rapids
Central EBP Regional Leader   Darlene Bayardo
National Assurance   Wendy Schmitz, Charlotte
Atlantic EBP Regional Leader   Mary Espinosa, Orange County
West EBP Regional Leader   Joanne Szupka, Philadelphia
Northeast EBP Regional Leader   Jody Hillenbrand, San Antonio
Southwest EBP Regional Leade   Jam Yap, Atlanta
Southeast EBP Regional Leader     [1] QNECs and QMACS are special discretionary contributions allowed in the plan document that are contributed to employees, using specific formulas, as a method of correcting testing failures. However, since these contributions are 100% vested and are non-forfeitable at the time they are allocated to participant accounts, this previously meant that forfeitures could not be used to fund those types of contributions.

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