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Initial Offerings Newsletter - Spring 2016

Mon, 04/04/2016 - 12:00am


U.S. IPO Activity Comes to Virtual Halt in Q1 of 2016 January's Highly Volatile Stock Market Led to Pull Back of Offerings
After several years of robust activity, stock market uncertainty has brought a deep freeze to initial public offering (IPO) activity in the U.S. during the initial months of 2016. In fact, January marked the first month that not a single IPO took place since September of 2011 when confidence was severely shaken during the Eurozone crisis.

With just 8 IPOs for the quarter, activity is down 76 percent from Q1 2015 and, similarly, total proceeds ($0.7 billion) are down 87 percent year-over-year. This makes Q1 2016 the least active quarter in both offering activity and proceeds raised in seven years (1 IPO and $0.7 billion in proceeds in Q1 2009), when markets were still roiling from the financial crisis.*

Certainly stock market volatility – the Dow plunged more than 1,000 points in one week this year - has played a major role in closing off the spigot of new offering businesses. However, there is a long list of additional factors – a perfect storm if you will – that have contributed to the lack of deals. They include:
 
  • Poor IPO Performance. A majority of the 170 companies that made their initial offerings last year are now trading below their IPO price. Poor returns lead to lack of appetite for additional risk.
  • Private Financing. The availability of private funding at very favorable valuations, especially in the technology sector, has led many potential IPO candidates to postpone their offerings indefinitely.
  • The M&A Alternative. Investors aren’t the only ones running from risk. A surge in M&A activity – deals reached an alltime high in 2015 - has led many IPO candidates to opt for the certainty of a sale over the risk of an offering.
Weak growth in China, the continued drop in oil prices and uncertainty surrounding interest rate hikes by the Federal Reserve are additional contributing factors to the dearth of offerings.



INDUSTRIES
All eight Q1 IPOs were in the healthcare/biotech sector. This continues an ongoing trend as the healthcare sector has led all industries for three consecutive years (2013-2015). 

Prior to the healthcare industry’s recent run of IPO leadership, the health of the U.S. IPO market was tightly linked to the offerings coming from the technology sector, as tech offerings led those of any other industry for six of the previous seven years (the lone exception was 2008 when the financial crisis brought activity to a halt). In recent years, the abundance of private financing at very favorable valuations has kept many of these technology companies away from the public markets. However, as public technology stocks trade down, these high valuations from private investors are likely to be increasingly difficult to achieve. Should private funding close up on these businesses, it could signal a return of tech companies to the public markets.

RECOVERY FORECAST
The uncertainty permeating today’s markets is reflected in investors retreat from risk. This severely impacts interest in IPOs, young startups with little history of profitability or revenue growth.

Public markets have seen a recovery from the major drops in January, but it will likely take a sustained rally before investors have the risk tolerance to support a robust IPO market. Those businesses that can accurately judge when investor’s appetite for risk has returned, are likely to be rewarded, but that is a difficult forecast to make.

Failing an unexpected debut by a big-name company, such as Uber, Airbnb or Snapchat, ‘caution’ is likely to remain the watchword for the investment community in the near term, making an increase in IPO activity a slow process.

When a recovery does occur, look for healthcare, technology and consumer businesses with strong growth profiles and name recognition to lead the way. A key component to the return of offerings is the ability of these businesses – especially technology companies – to reconcile the valuation differences between the public and private markets.

Once offering businesses decide to ‘bite the bullet’ and accept pricings at current public valuations, the table will be set for stronger IPO performance. Improved performance will lead to more offerings, which will eventually lead to better pricings.

* Renaissance Capital is the source for all historical data related to the number, size and returns of U.S. IPOs.

For more information on BDO’s Capital Markets services, please contact one of the regional leaders:
Lee Duran, San Diego; Paula Hamric, Chicago; Chris Smith, Los Angeles; Ted Vaughan, Dallas

BDO Comment Letter - Classification of Certain Cash Receipts and Cash Payments

Mon, 03/28/2016 - 12:00am
Classification of Certain Cash Receipts and Cash Payments (File Reference No. EITF-15F)  

BDO supports the proposed changes on reporting certain items in the cash flow statement, but recommends certain clarifications in the final ASU.
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Elevating Cybersecurity to the Board – Questions Boards Should Be Asking

Mon, 03/28/2016 - 12:00am



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The board’s role in the oversight of organizational risk is increasingly complicated by cybersecurity concerns. Directors need to maintain continual knowledge about evolving cyber issues and management’s plans for allocating resources with respect to the preparedness in responding to cyber risks. Such knowledge helps boards assess the priority-driven and investment decisions put forth by management needed in critical areas.

BDO has prepared the following compilation of critical questions that boards and management should be considering with respect to mitigating cyber security risk for their organizations. Questions contemplate the general to the specific, with concentrations on strategy, organizational risk profile, cyber maturity, metrics, cyber incident management and resilience, and continuing education. These questions may be useful as a starting point for boards to use in their discussions with and in the oversight of management’s plans for addressing potential cyber risks.
 

GENERAL
  • What are the potential cyber threats to the organization?
  • Currently, do boards feel they are adequately up to speed on cybersecurity issues impacting their organizations?
  • Do boards currently have the skill sets necessary to adequately address cybersecurity?
  • What should the board be focused on with respect to cybersecurity?
  • What is a suggested interaction model between senior management and the board  for cybersecurity?
  • Has the regulatory focus on the board’s cybersecurity responsibility been increasing?  If so, what is driving that focus?
 
OVERALL CYBERSECURITY STRATEGY
  • Does the board need to play a more active part in determining an organization’s cybersecurity strategy?
  • What are the key elements of a good cybersecurity strategy?
  • Is the organization’s cybersecurity preparedness receiving the appropriate level of time and attention from management and the board (or appropriate board committee)?
  • How can management and the board (or appropriate board committee) make this process part of the organization’s enterprise-wide governance framework?
  • How can management and the board (or appropriate board committee) support improvements to the organization’s process for conducting a cybersecurity assessment?

 RISK ASSESSMENT: RISK PROFILE
  • Is the organization a direct target of cyber attacks?
  • What do the results of the cybersecurity assessment mean to the organization as it looks at its overall risk profile?
  • What are the organization’s areas of highest inherent risk?
  • Is management updating the organization’s inherent risk profile to reflect changes in activities, services, and products?



RISK ASSESSMENT: CYBER MATURITY Oversight
  • Who is accountable for assessing and managing the risks posed by changes to the business strategy or technology and are those individuals empowered to carry out those responsibilities?
  • Do the inherent risk profile and cybersecurity maturity levels meet management’s business and risk management expectations? If there is misalignment, what are the proposed plans to bring them into alignment?
Cybersecurity Controls
  • Do the organization’s policies and procedures demonstrate management’s commitment to sustaining appropriate cybersecurity maturity levels?
  • What is the ongoing practice for gathering, monitoring, analyzing, and reporting risks?
  • How effective are the organization’s risk management activities and controls identified in the assessment?
  • Are there more efficient or effective means for achieving or improving the organization’s risk management and control objectives?
Threat Intelligence and Collaboration
  • What is the process for gathering and validating inherent risk profile and cybersecurity maturity information?
External Dependency Management
  • What third parties does the organization rely on to support critical activities?
  • What is the process to oversee third parties and understand their inherent risks and cybersecurity maturity?

CYBERSECURITY METRICS
  • How should a board obtain IT metric information?
  • Who should deliver IT metrics?
  • What should IT metrics contain? In what format should it be presented?
  • Is the information meaningful in a way that invokes a reaction and provides a clear understanding of the level of risk willing to be accepted, transferred, or mitigated?

CYBER INCIDENT MANAGEMENT & RESILIENCE
  • How does management validate the type and volume of cyber attacks?
  • Does the organization have a comprehensive cyber breach response and recovery plan?
  • How does an incident response and recovery plan fit into the overall cyber security strategy?

CYBERSECURITY EDUCATION
  • How does the board remain current on cybersecurity developments in the market and the regulatory environment?
For more on managing risk related to the governance of cyber security, refer to BDO’s archived webinar and self-study course: Managing Risk – Elevating Cybersecurity to the Boardroom.

For questions related to matters discussed above, please contact Shahryar ShaghaghiMichael Van StrienMaurice Liddell, or Amy Rojik.
 

The BDO 600

Mon, 03/28/2016 - 12:00am


The BDO 600 survey details director compensation practices of publicly traded companies in the energy, financial services–banking, financial services–nonbanking, healthcare, manufacturing, real estate, retail and technology industries.
 
Companies in the six nonfinancial service industries have annual revenues between $25 million and $1 billion. Companies in the two financial services industries have assets between $50 million and $2 billion.
 
All data in our survey was extracted from proxy statements that were filed between May 15, 2014 and May 15, 2015.
 
This survey is unique because it focuses on mid-market companies; whereas most other board compensation surveys focus on much larger companies.
  Download Study

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FASB Flash Report - March 2016

Mon, 03/28/2016 - 12:00am
FASB Clarifies Principal versus Agent Considerations Under Topic 606
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Summary The FASB recently issued ASU 2016-081 to clarify the principal versus agent guidance within the new revenue standard. However, the core principle in Topic 6062 is unchanged. The ASU is available here, and becomes effective concurrently with the new revenue standard, i.e., in 2018 for public entities and 2019 for all other entities.
Details

Background
Topic 606 contains guidance on principal versus agent assessments when a third party is involved in providing goods or services to a customer. It specifies that an entity is a principal, and thus records revenue on a gross basis, if it controls a good or service before transferring the good or service to the customer. An entity is an agent, and thus records revenue on a net basis, if it arranges for a good or service to be provided by another entity. The guidance contains indicators and examples to assist with the analysis.

In this context, the Joint Transition Resource Group deliberated certain implementation questions relating to the principal versus agent analysis, which led the FASB and IASB to clarify their new revenue standards.

Main Provisions
ASU 2016-08 clarifies the principal versus agent implementation guidance in the following areas:

  • Unit of account at which the principal/agent determination is made
  • Applying the control principle to certain types of transactions
  • The control principle and principal/agent indicators
  • Examples
Unit of account at which the principal/agent determination is made
 
The amendments require an entity to determine whether it is a principal or an agent for each distinct good or service (or a distinct bundle of goods or services) to be provided to the customer, based on paragraphs 606-10-25-19 through 25-22. If a contract with a customer includes more than one distinct good or service, an entity could be a principal for some and an agent for others.3
 
As part of this assessment – determining whether the entity provides a distinct good or service (principal) or merely arranges for a third party to do so (agent) – the entity should assess whether it controls each good or service before it is transferred to the customer. That is, an entity can only be a principal if it controls the good or service beforehand.
 
Applying the control principle to certain types of transactions
 
The amendments illustrate how an entity that is a principal might apply the control principle to goods, services, or rights to services, when another party is involved in providing goods or services to a customer. Specifically, an entity that is a principal could obtain control of (a) a good or another asset from the other party that it then transfers to the customer, e.g., inventory; (b) a right to a service that will be performed by another party (e.g., a cleaning service), which gives the entity the ability to direct that party to provide the service to the customer on the entity’s behalf; or (c) a good or service from the other party that it combines with other goods or services to provide the specified good or service to the customer (e.g., combining specialized equipment manufactured by a third party with the entity’s project management service).
 
The control principle and principal/agent indicators
 
The amendments clarify that the purpose of certain specific control indicators4 is to support or assist in the assessment of whether an entity controls a specified good or service before it is transferred to the customer. They do not override the control principle.
 
The amendments provide more specific guidance of how the indicators should be considered, and also clarify that their relevance will vary depending on the facts and circumstances.
   
BDO Observation: The control indicators discussed in the amendments are similar to those in existing revenue recognition guidance. However, they serve a different purpose in ASC 606, namely to assist in identifying performance obligations and in assessing the transfer of control (instead of “risks and rewards”). Because of this difference, the FASB acknowledged that some principal versus agent conclusions could be different under ASC 606 than those reached under the previous revenue recognition guidance.5 As a result, companies will need to carefully consider whether they serve as a principal or an agent in each of their revenue streams involving a third party as part of applying ASC 606.
 
Examples
 
The ASU revises existing examples and adds two new ones to more clearly depict how the guidance should be applied.
Effective Date and Transition The effective date and transition requirements for ASU 2016-08 are the same as the effective date and transition requirements of Topic 606, specifically:
 
Public business entities will adopt the standard for annual reporting periods beginning after December 15, 2017, including interim periods within that year. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim periods within that year.6
 
All other entities will adopt the standard for annual reporting periods beginning after December 15, 2018, and interim periods within annual reporting periods beginning after December 15, 2019. Early adoption is permitted as of either:
  • An annual reporting period beginning after December 15, 2016, including interim periods within that year, or
  • An annual reporting period beginning after December 15, 2016 and interim periods within annual reporting periods beginning one year after the annual period in which an entity first applies the new standard.

International Convergence
The International Accounting Standards Board is expected to release Clarifications to IFRS 15, which will contain substantially converged amendments of IFRS 15.
 


For questions related to matters discussed above, please contact Ken GeeAngela Newell or Adam Brown



Principal versus Agent Considerations (Reporting Revenue Gross versus Net) 2 Revenue from Contracts with Customers
3 The FASB has a related project to clarify the guidance on identifying distinct goods or services, with a final ASU expected in the near term. 4 See paragraph 606-10-55-39. 5 See BC15 – BC20 of the ASU. 6 A not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market, and an employee benefit plan that files or furnishes financial statements with or to the SEC have the same effective date as public business entities.

FASB Flash Report - March 2016

Tue, 03/22/2016 - 12:00am
FASB Simplifies Transitioning to the Equity Method of Accounting  
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Summary The FASB recently issued ASU 2016-071 to eliminate the requirement to retroactively adopt the equity method of accounting when an investment qualifies for using the equity method due to an increase in the level of ownership interest or degree of influence. In that situation, the ASU requires an investor to apply the equity method only on a go-forward basis.  The ASU is effective in 2017 and is available here.  Early adoption is permitted.
Background When an investment becomes qualified for equity method accounting, existing US GAAP requires an investor to retroactively adjust the investment and record a cumulative catch up for the periods that the investment had been held, but did not qualify for the equity method of accounting. This can be quite costly, with little perceived incremental benefit to users of the financial statements.
Main Provisions This Update simplifies US GAAP to require an investor to apply the equity method only from the date it qualifies for that method, e.g., the date the investor obtains significant influence over the operating and financial policies of an investee. 
 
Specifically, when an investment that was previously accounted for under other guidance qualifies for the equity method of accounting, an investor should:
  • Add the cost of acquiring the additional interest in the investee to the current basis of the investor’s existing interest.
  • Recognize in earnings the unrealized holding gain or loss in accumulated other comprehensive income, if the existing investment was accounted for as an available-for-sale equity security.
  • Apply the equity method of accounting as of that date, i.e., no retroactive adjustment of the investment is required. 

Effective Date and Transition The amendments are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016.  The amendments should be applied prospectively upon their effective date to increases in the level of ownership interest or degree of influence that result in the application of the equity method. Early adoption is permitted.
  On the Horizon The FASB had additionally proposed eliminating the requirement by investors to account for any basis differences arising under the equity method of accounting.  Due to stakeholder concerns, the Board decided to perform additional research on basis differences as part of a larger effort to consider other potential improvements to the equity method of accounting. 

For questions related to matters discussed above, please contact Gautam GoswamiAngela Newell or Adam Brown.

1 Investments—Equity Method and Joint Ventures (Topic 323), Simplifying the Transition to the Equity Method of Accounting

 

FASB Flash Report - March 2016

Mon, 03/21/2016 - 12:00am
FASB Issues ASU on Contingent Put and Call Options in Debt Instruments
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Summary The FASB recently issued ASU 2016-061 on how to assess whether contingent call (put) options that can accelerate the payment on debt instruments are clearly and closely related to their debt hosts. This assessment is necessary to determine if the option(s) must be separately accounted for as a derivative. The ASU clarifies that an entity is required to assess the embedded call (put) options solely in accordance with a specific four-step decision sequence. This means entities are not also required to assess whether the contingency for exercising the option(s) is indexed to interest rates or credit risk. The ASU is available here and becomes effective for public entities in 2017. Early adoption is allowed.
Background Topic 8152 requires that embedded derivatives be bifurcated from the host contract and accounted for separately as derivatives if certain criteria are met. One of those criteria is that the economic characteristics and risks of the embedded derivatives are not clearly and closely related to the economic characteristics and risks of the host contract. For example, this guidance addresses whether a put feature in a loan that is exercisable upon a change of control of the issuer should be bifurcated and separately accounted for as a derivative.
 
More specifically, paragraph 815-15-25-42 provides a four-step decision sequence for determining whether call (put) options that can accelerate the settlement of debt instruments are clearly and closely related to the debt host contract. Those four factors consider whether:
 
i. the payoff is adjusted based on changes in an index
ii. the payoff is indexed to an underlying besides interest rates or credit risk
iii. the debt payoff involves a substantial premium or discount, and
iv. the call (put) option is contingently exercisable. 

Diversity in practice exists currently whereby some entities assess whether the event that triggers the ability to exercise the call (put) option is indexed only to interest rates or credit risk, in addition to applying the four-step decision sequence. Other entities solely apply the four-step decision sequence.
  Main Provisions Under the ASU, entities that are issuers of or investors in debt instruments (or hybrid financial instruments that are determined to have a debt host) should not analyze whether the event that triggers the ability to exercise the call (put) option is indexed only to interest rates or credit risk. Rather, an entity is solely required to assess the embedded call (put) options under the four-step decision sequence summarized above. For example, when evaluating debt instruments puttable upon a change in control, the event triggering the change in control is not relevant to the assessment. Only the resulting settlement of debt is subject to the four-step decision sequence.
  Effective Date and Transition The amendments are effective for public business entities for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2017, and interim periods within fiscal years beginning after December 15, 2018. Early adoption is permitted. However, If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of that fiscal year.
 
The amendments must be applied on a modified retrospective basis to existing debt instruments as of the beginning of the fiscal year for which the amendments are effective.
 
If an entity previously bifurcated an embedded derivative but is no longer required to do so under the ASU, the fair value of the derivative should be combined with the book value of the debt instrument upon adoption. At that time, an entity will have a one-time option to elect to measure the combined debt instrument at fair value with changes in fair value recognized in earnings under Topic 825.3 Alternatively, an entity should apply other U.S. GAAP to the debt instrument.  Certain additional transition provisions apply.

For questions related to matters discussed above, please contact Gautam Goswami, Angela Newell or Adam Brown.
 
1 Contingent Put and Call Options in Debt Instruments
2 Derivatives and Hedging
3 Financial Instruments

 

FASB Flash Report - March 2016

Fri, 03/18/2016 - 12:00am
FASB Issues ASU on the Effect of Derivative Contract Novations on Existing Hedges
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Summary The FASB recently issued ASU 2016-051 to clarify that a change in the counterparty to a derivative instrument that has been designated as a hedging instrument does not, on its own, require dedesignation of that hedge accounting relationship provided that all other hedge accounting criteria continue to be met. The ASU is available here, and becomes effective for public entities in 2017. Early adoption is allowed.
Main Provisions The term novation, as it relates to derivative instruments, refers to replacing one of the parties to a derivative instrument with a new party, which may occur for a variety of business or regulatory reasons. The derivative instrument that is the subject of a novation may be the hedging instrument in a designated hedging relationship.
 
ASC 8152 requires an entity to discontinue the designated hedging relationship in certain cirmstances, including termination of the derivative hedging instrument or if the entity wishes to change any of the critical terms of the hedging relationship. The ASU amends Topic 815 to clarify that novation of a derivative designated as the hedging instrument would not, in and of itself, be considered a termination of the derivative instrument or a change in critical terms requiring discontinuation of the designated hedging relationship.  
  BDO Observation While clarifying the novation, in and of itself, does not preclude continued use of hedge accounting, the basis for conclusions to the ASU notes that in determining whether the hedging relationship continues to qualify for hedge accounting, the counterparty default guidance in ASC 815 requires entities to always assess the creditworthiness of a derivative counterparty in a hedging relationship—both in the normal course and upon a novation.
  Effective Date and Transition The amendments are effective for public business entities for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2017, and interim periods within fiscal years beginning after December 15, 2018. Early adoption is permitted.
 
The amendments may be applied on either a prospective or a modified retrospective basis. The modified retrospective approach is only available when certain specific conditions are met and is also subject to detailed transition guidance.

For questions related to matters discussed above, please contact Gautam Goswami, Angela Newell or Adam Brown


1 Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships
2 Derivatives and Hedging
 

FASB Flash Report - March 2016

Wed, 03/16/2016 - 12:00am
FASB Issues ASU on Recognizing Breakage for Prepaid Stored-Value Products
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Summary The FASB recently issued ASU 2016-041 to address an issuer’s liability for gift cards and other prepaid stored-value products that are not expected to be redeemed by customers. Specifically, an entity should use a “breakage” method consistent with the new revenue standard in Topic 6062 to recognize these amounts in earnings, rather than waiting until the entity is legally released from the liability or it is actually redeemed (which may never occur). The ASU is available here, and becomes effective for public entities in 2018, although early adoption is allowed.    
Details Background
ASU 2016-04 describes “prepaid stored-value products” as products in physical and digital forms with stored monetary values that are issued for the purpose of being commonly accepted as payment for goods or services, and which occasionally may also offer cash settlement options. Examples of prepaid stored-value products include prepaid gift cards issued on a specific payment network, prepaid phone cards and traveler’s checks. “Breakage” is the portion of the dollar value of prepaid stored-value products that ultimately is not redeemed by customers.
 
Main Provisions
ASU 2016-04 amends Subtopic 405-203 to exempt prepaid stored-value products from the guidance on extinguishing financial liabilities. Rather, they will be subject to breakage accounting consistent with the new revenue standard in Topic 606. However, the exemption only applies to breakage liabilities that that are not subject to unclaimed property laws or that are attached to segregated bank accounts, for instance consumer debit cards.  Further, the ASU does not apply to customer loyalty programs or other transactions that are within the scope of other GAAP, including Topic 606.
  BDO Observation: Determining whether breakage liabilities are subject to unclaimed property laws is a legal question, and may require judgment as the laws often vary by state. As a result, a company could have multiple breakage liabilities that are accounted for differently. As such, entities may need to consult with unclaimed property specialists.

Separately, this guidance does not address the accounting for dormancy or other fees charged to holders of unused stored-value products.
The amendments provide that if an entity expects to be entitled to breakage, it should derecognize the amount of the liability in proportion to the pattern of rights expected to be exercised by the product holder.  In addition, breakage should only be recognized to the extent that it is probable that a significant reversal of the recognized breakage amount will not subsequently occur.

The amendments also require entities to update their estimates of breakage at the end of each reporting period, with changes accounted for as a change in accounting estimate.

If an entity does not expect to be entitled to breakage, the entity should derecognize such liabilities within the scope of the ASU when the likelihood of the product holder exercising its remaining rights becomes remote.

In the notes to the financial statements, entities should disclose the methodology used to recognize breakage and significant judgments made in applying the breakage methodology. Liabilities resulting from the sale of prepaid stored-value products within the scope of the ASU are exempt from the fair value disclosure guidance of Topic 825.4
  Effective Date and Transition The amendments are effective for public business entities5 for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The amendments are effective for all other entities for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. Early adoption is permitted. An entity will adopt the new guidance either using a modified retrospective transition method by means of a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year in which the guidance is effective or retrospectively to each period presented.

For GAAP-related questions, please contact Angela Newell or Adam Brown

For Unclaimed Property/Escheat-related questions, please contact Joe Carr or Michael Kenehan.

1 Recognition of Breakage for Certain Prepaid Stored-Value Products
2 Revenue from Contracts with Customers
3 Liabilities—Extinguishments of Liabilities
4 Financial Instruments
5 The public business entity effective date also applies to (1) a not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an-over-the-counter market, and (2) an employee benefit plan that files or furnishes statements with or to the SEC.

FASB Flash Report - March 2016

Mon, 03/14/2016 - 12:00am
FASB Removes Effective Dates of Private Company Accounting Alternatives
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Summary The FASB recently issued ASU 2016-031 to remove the effective dates from the private company accounting alternatives for goodwill, intangible assets, consolidation, and derivatives and hedging. This allows private companies to elect the accounting alternatives at any time without a preferability assessment. The ASU also extends certain favorable transition provisions of the accounting alternatives. The ASU is available here, and is effective immediately.
Main Provisions During 2014, the FASB provided four accounting alternatives for private companies,2 intending to provide relief in areas where the costs of complying with existing U.S. GAAP may outweigh the related benefits to users of private company financial statements. The amendments in ASU 2016-03 make those alternatives effective immediately—and on an ongoing basis for first time adopters—by eliminating the effective dates of the following ASUs:
  • ASU 2014-02, Intangibles - Goodwill and Other (Topic 350): Accounting for Goodwill
  • ASU 2014-03, Derivatives and Hedging (Topic 815): Accounting for Certain Receive- Variable, Pay Fixed Interest Rate Swaps – Simplified Hedge Accounting Approach
  • ASU 2014-07, Consolidation (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements
  • ASU 2014-18, Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination 

By removing the effective dates of the guidance above, ASU 2016-03 allows private companies to forgo a preferability assessment the first time they elect the accounting alternatives. However, any subsequent change to an accounting policy election would require justification that the change is preferable under Topic 250, Accounting Changes and Error Corrections.
 
In addition, the amendments extend the transition guidance in ASUs 2014-02, 2014-03, 2014-07, and 2014-18 indefinitely.  As such, under ASU 2016-03 private companies may:
  • Elect the goodwill accounting alternative as of the beginning of the first annual period it is elected for existing goodwill and prospectively for new goodwill. 
  • Elect the simplified hedge accounting approach to existing swaps upon initial election of the alternative using a modified retrospective approach or a full retrospective approach (however, the transition provisions do not apply to subsequent elections of the simplified hedge accounting approach).
  • Elect the VIE exemption retrospectively for all periods presented.  This transition method is unchanged from prior guidance.
  • Elect the option for intangible assets for the first eligible transaction that occurs in the annual reporting period it is adopted. This transition method is unchanged from prior guidance. 

Effective Date and Transition The amendments became effective immediately upon issuance of the ASU.

For questions related to matters discussed above, please contact Gautam Goswami, Angela Newell or Adam Brown.

1 Intangibles—Goodwill and Other (Topic 350), Business Combinations (Topic 805), Consolidation (Topic 810), Derivatives and Hedging (Topic 815): Effective Date and Transition Guidance

2 Generally, a private company is an entity other than a public business entity, a not-for-profit entity, or an employee benefit plan within the scope of Topics 960 through 965 on plan accounting. Each private company accounting alternative establishes its own scope.
 

BDO Shareholder Meeting Alert - March 2016

Mon, 03/07/2016 - 12:00am


Mergers & Acquisitions, Currency Risk, Cybersecurity, Board Compensation and Executive Compensation Among Top Issues at 2016 Shareholder Meetings
A highly volatile stock market, stagnant wages, global economic challenges, a strong U.S. dollar and a presidential election like no other are just a few of the factors contributing to a growing feeling of uncertainty in corporate board rooms around the country. This unsettled climate should make for an interesting annual meeting season this spring.
 
The following thought leadership piece covers those topics that corporate management and boards of directors may want to be prepared to address in connection with their 2016 annual meetings. These reflect individual as well as inter-related areas of corporate financial and operational risk and strategy that may require significant time and attention by boards and management teams of companies of all sizes and across all industries. Where appropriate, topics have been aligned with additional pieces of thought leadership and/or learning opportunities for further consideration.
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FASB Flash Report - March 2016

Tue, 03/01/2016 - 12:00am
FASB Issues ASU on Leases
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Summary On February 25, 2016, the FASB issued its highly-anticipated leasing standard1 for both lessees and lessors. Under its core principle, a lessee will recognize lease assets and liabilities on the balance sheet for all arrangements with terms longer than 12 months. Lessor accounting remains largely consistent with existing U.S. GAAP. The new standard takes effect in 2019 for public business entities and 2020 for all other entities. The ASU is available here.
Main Provisions Lessee Accounting Model
The new standard applies a right-of-use (ROU) model that requires a lessee to record, for all leases with a lease term of more than 12 months, an asset representing its right to use the underlying asset for the lease term and a liability to make lease payments. The lease term is the noncancellable period of the lease, and includes both periods covered by an option to extend the lease, if the lessee is reasonably certain to exercise that option, and periods covered by an option to terminate the lease, if the lessee is reasonably certain not to exercise that termination option. 

BDO Observation: “Reasonably certain” has the same meaning as “reasonably assured” under existing U.S. GAAP, and includes an assessment of economic incentives.

For leases with a lease term of 12 months or less, a practical expedient is available whereby a lessee may elect, by class of underlying asset, not to recognize an ROU asset or lease liability. A lessee making this accounting policy election would recognize lease expense over the term of the lease, generally in a straight-line pattern. 

At inception, lessees must classify all leases as either finance or operating. Balance sheet recognition of finance and operating leases is similar, but the pattern of expense recognition in the income statement will differ depending on the lease classification. A finance lease is a lease arrangement in which the lessee effectively obtains control of the underlying asset. In an operating lease, the lessee does not effectively obtain control of the underlying asset. 

If any of the following criteria is met at commencement, a lessee effectively obtains control of an underlying asset and will account for the lease as a finance lease:
  1. The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
  2. The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise.
  3. The lease term is for the major part of the remaining economic life of the underlying asset.
  4. The sum of the present value of the lease payments and the present value of any residual value guaranteed by the lessee amounts to substantially all of the fair value of the underlying asset.
  5. The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.  
The following table compares lessee accounting for finance and operating leases:
  Financial Statement Finance Lease Operating Lease  Balance Sheet Recognize ROU asset and lease liability, initially measured at the present value of the lease payments. Include initial direct costs in the initial measurement of the ROU asset. Recognize ROU asset and lease liability, initially measured at the present value of the lease payments. Include  initial direct costs in the initial measurement of the ROU asset.  Income Statement Recognize interest on the lease liability separately from amortization of the ROU asset. Recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, generally on a straight-line basis.  Cash Flows Classify repayments of the principal portion of the lease liability within financing activities and payments of interest on the lease liability and variable lease payments within operating activities. Classify all cash payments for leases within operating activities.

BDO Observation: Finance leases will result in a “front-loaded” expense effect due to straight-line amortization and front-loaded interest, while operating leases will result in straight-line expense recognition over the lease term, similar to today’s operating lease treatment.  

After inception, the lessee’s right-of-use asset will be assessed for impairment under Topic 360.

Lessor Accounting Model
The new standard requires a lessor to classify leases as either sales-type, direct financing or operating, similar to existing U.S. GAAP.  Classification depends on the same five criteria used by lessees plus certain additional factors. Based on that evaluation: 
  1. A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. 
  2. If risks and rewards are conveyed without the transfer of control, the lease is treated as a direct financing.  
  3. If the lessor doesn’t convey risks and rewards or control, an operating lease results.
The subsequent accounting treatment for all three lease types is substantially equivalent to existing U.S. GAAP for sales-type leases, direct financing leases, and operating leases. However, the new standard updates certain aspects of the lessor accounting model to align it with the new lessee accounting model. For instance, glossary terms have been standardized such that a lessee applying the guidance as a sublessor would apply the same terms as a lessor. Further, guidance for lessors has been aligned with the revenue recognition guidance in ASU 2014-092 due to the revenue-generating nature of leasing activities for lessors. Specifically, determining whether a lease is a sale is based on the notion of transfer of control, which is the same principle underlying the new revenue guidance; a lessor is precluded from recognizing selling profit or sales revenue at lease commencement for a lease that does not transfer control of the underlying asset to the lessee. Also consistent with the new revenue guidance, the updated lessor accounting model does not differentiate between leases of real estate and leases of other assets.

With respect to impairment, Topic 310 applies to a lessor’s net investment in the lease. Topic 360 continues to apply to long-lived assets of lessors.

The previous accounting model for leveraged leases will continue to apply only for those leveraged leases that commenced before the effective date, but will not be available for leases that commence after the effective date. 

Additional Considerations
Identification of a Lease – The new standard defines a lease as a contract that conveys the right to use an underlying asset for a period of time in exchange for consideration. 

BDO Observation: Determining whether a contract contains a lease at inception is critical under the new guidance because of the requirement to recognize ROU assets and lease liabilities on the balance sheet. While this assessment will be straight-forward in most cases, it may require judgment in some situations, such as contracts that include services.

Components – Lessees and lessors are required to separate the lease components from the nonlease components (for example, maintenance services or other activities that transfer a good or service to the customer) in a contract, and account for the nonlease components according to other applicable guidance. However, a practical expedient is available whereby lessees may elect, by class of underlying asset, not to separate lease components from nonlease components, and to account for all components as a single lease component.  

Sale and Leaseback Transactions - For a sale to occur in the context of a sale and leaseback transaction, the transfer of the asset must meet the requirements for a sale in ASU 2014-09. If there is no sale for the seller-lessee, the buyer-lessor also does not account for a purchase.

Modifications – The new standard provides guidance for determining whether lease modifications should be accounted for as separate leases. It also specifies the modification accounting for both lessees and lessors.  

Disclosures – Lessees and lessors are required to provide certain qualitative and quantitative disclosures to enable users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases.

BDO Observation: SEC registrants are also required to disclose the impact that recently issued accounting standards will have on the financial statements when adopted in a future period.  Refer to BDO’s recent SEC flash report for details.

Other – The new standard provides guidance on combining contracts, purchase options, reassessment of the lease term, and remeasurement of lease payments. It also contains comprehensive implementation guidance with practical examples. 

Effective Date and Transition: The amendments are effective for public business entities3 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The amendments are effective for all other entities for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted. 

In transition, a lessee and a lessor will recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients. These practical expedients relate to identifying and classifying leases that commenced before the effective date, initial direct costs for leases that commenced before the effective date, and the ability to use hindsight in evaluating lessee options to extend or terminate a lease or to purchase the underlying asset.

An entity that elects to apply the practical expedients would, in effect, continue to account for leases that commenced prior to the effective date in accordance with previous guidance unless the lease is modified, except that lessees would recognize an ROU asset and a lease liability for all operating leases at each reporting date based on the present value of the minimum rental payments that were determined under previous guidance.

The new standard also provides transition guidance specific to sale and leaseback transactions, build-to-suit leases, leveraged leases, and leases recognized as a result of a business combination.

International Convergence: The lease project began as a joint project with the IASB. The IASB released its final standard, IFRS 16 Leases, in January 2016. Although many aspects of the two standards are converged, there are significant differences, the most notable of which is the lessee accounting model. IFRS 16 does not differentiate between finance and operating leases, but rather treats all leases of assets with values greater than $5,000 as finance leases. This means leases classified as operating leases under U.S. GAAP will be accounted for differently than under IFRS, resulting in different patterns in the income statement and cash flow statement. 

For questions related to matters discussed above, please contact Adam Brown, Angela Newell, or Chris Smith.

1 Leases (Topic 842)

2 Revenue from Contracts with Customers (Topic 606)

3 The public business entity effective date also applies to (1) a not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an-over-the-counter market, and (2) an employee benefit plan that files or furnishes statements with or to the SEC.

BDO Comment Letter - Disclosure Framework

Mon, 02/29/2016 - 12:00am
Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement
(File Reference No. 2015-350)

BDO supports the proposed changes for fair value disclosures, but believes additional changes may be necessary.
Download

BDO Comment Letter - Government Assistance

Tue, 02/09/2016 - 12:00am
Government Assistance (Topic 832): Disclosures by Business Entities About Government
Assistance (File Reference No. 2015-340)

BDO believes the costs of preparing the proposed disclosures about government assistance will exceed the related benefits.
Download

SEC Flash Report - February 2016

Fri, 02/05/2016 - 12:00am
SAB 74 Disclosures Related to Expected Accounting Standard on Leases   Download PDF Version

The FASB is expected to issue its new standard on leases in February.  When it does, SEC registrants will need to begin assessing their disclosures under Staff Accounting Bulletin No. 74 (codified in SAB Topic 11-M) in their next annual and interim filings, including annual reports on Form 10-K for the year ended December 31, 2015 which have not yet been filed with the SEC.  SAB 74 addresses disclosure of the impact that recently issued accounting standards will have on the financial statements of the registrant when adopted in a future period. 
 
Companies will understandably need time to assess the standard’s effects on their financial statements.  Accordingly, the initial SAB 74 disclosures about the standard’s effect may be general in nature.  Examples of disclosure that might be made in the initial reporting periods following the issuance of the new standard, depending on whether the entity is a lessee, lessor, or both are shown below (please note that a registrant must include actual ASU references):   
 
Lessees

In February 2016, the FASB issued Accounting Standards Update No. 2016-XX, Leases. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement.

The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.

[We are currently evaluating the impact of our pending adoption of the new standard on our consolidated financial statements.]

OR

[While we are still evaluating the impact of our pending adoption of the new standard on our consolidated financial statements, we expect that upon adoption we will recognize ROU assets and lease liabilities and that the amounts could be material.]
 

Lessors

In February 2016, the FASB issued Accounting Standards Update No. 2016-XX, Leases. The new standard requires a lessor to classify leases as either sales-type, finance or operating.  A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing.  If the lessor doesn’t convey risks and rewards or control, an operating lease results.

The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessors for sales-type, direct financing, and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.
We are currently evaluating the impact of our pending adoption of the new standard on our consolidated financial statements.


These disclosures will be expected to evolve over time as companies begin to better understand how the standard will impact their financial statements.  As encouraged by SAB 74, registrants should also consider making disclosure of the potential impact of other significant matters that may result from the adoption of the standard (e.g. technical violations of debt covenants or planned changes in business practices).   

For questions related to matters discussed above, please contact Jennifer Kimmel or Jeff Lenz.

BDO Comment Letter - Clarifying the Definition of a Business

Fri, 01/22/2016 - 12:00am
Clarifying the Definition of a Business (File Reference No. 2015-330)

We are pleased to provide comments on the Board’s proposal to clarify the definition of a business within Topic 805.
  Download

Significant Accounting & Reporting Matters Q4 2015

Wed, 01/20/2016 - 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. 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.

Highlighted in this issue:
  • Financial accounting headlines, including:
    • FASB Simplifies Balance Sheet Presentation of Income Taxes
    • FASB Proposes to Amend the Definition of a Business
  • SEC & PCAOB highlights, including:
    • FAST Act Amends SEC Reporting Requirements
    • SEC Adopts Regulation Crowdfunding
    • And more!
  Download

SEC Flash Report - January 2016

Wed, 01/20/2016 - 12:00am
SEC Issues Interim Final Rules Implementing FAST Act Provisions Download PDF Version
Details On January 13, the SEC issued interim final rules to implement certain securities law amendments which were part of the Fixing America’s Surface Transportation (FAST) Act.1 The adopting release is available here on the
SEC’s website.

These rules:
  • Revise the general instructions to Form S-1 and Form F-1 to reflect one of the FAST Act’s self-executing changes which permits an emerging growth company conducting an initial public offering to omit historical periods from its financial statements if it reasonably expects that such periods will not be required at the time of the offering.2 The preliminary prospectus distributed to investors must contain all financial information required by Regulation S-X.
  • Revise Item 12 of Form S-1 (and make a conforming change to Item 512(a) of Regulation S­K) to permit a smaller reporting company to forward incorporate information by reference. Only smaller reporting companies that are not blank check companies, shell companies (other than business combination related shell companies) or issuers in offerings of penny stock are eligible to take advantage of this provision.
The self-executing changes discussed in the first bullet above have already taken effect. The rules above become effective when they are published in the Federal Register. The SEC is soliciting feedback on whether the amendments should be extended to other registrants or other forms.  The comment period will remain open for 30 days following the date these rules are published in the Federal Register.

For questions related to matters discussed above, please contact Jeffrey Lenz or Paula Hamric.

1 Further information on the FAST Act can be found here in a BDO Flash Report.
2 Applies to confidentially submitted and filed registration statements.
 

EBP Commentator - Winter 2016

Tue, 01/19/2016 - 12:00am


Download PDF Version
FASB’s ASU 2015-12 Simplifies Financial Reporting for EBPs Plan sponsors (and plan advisors) often struggle with the appropriate application of new accounting pronouncements due to limited and/or complex technical guidance on implementation. The Financial Accounting Standards Board (FASB) has provided relief for financial reporting for employee benefit plans (EBPs) with the issuance of Accounting Standards Update (ASU) 2015-12, Plan Accounting: Defined Benefit Pension Plans (Topic 960), Defined Contribution Pension Plans (Topic 962), Health and Welfare Benefit Plans (Topic 965): (Part I) Fully Benefit-Responsive Investment Contracts, (Part II) Plan Investment Disclosures, (Part III) Measurement Date Practical Expedient (ASU). This ASU is part of the FASB’s Simplification Initiative, which is an ongoing effort to improve the usefulness of the information provided to users of the financial statements while reducing costs and complexity related to financial reporting by EBPs. The ASU is divided in three parts and applies to plan accounting of certain benefit plans. 
Part I - Fully Benefit-Responsive Investment Contracts The guidance in Part I of the ASU applies to reporting entities within the scope of Topics 962 (Plan Accounting - Defined Contribution Pension Plans) and 965 (Plan Accounting - Health and Welfare Benefit Plans) that classify investments as fully benefit-responsive investment contracts (FBRICs) (e.g. guaranteed investment contracts or GICS).

To better comprehend the impact of this new guidance, it is important to first understand what was required under the old guidance. Prior to ASU 2015-12, generally accepted accounting principles in the United States of America (U.S. GAAP) required an entity to measure FBRICs at both contract value (for purposes of determining the net assets available for benefits) and fair value (for purposes of presentation and disclosure). In addition, U.S. GAAP required an adjustment on the face of the statements of net assets available for benefits to reconcile fair value to contract value (if the measured values differed).

Part I of the new ASU clarifies that contract value is the only required measurement for FBRICs. Contract value is considered to be the most relevant measurement since that is the amount at which plan participants would transact. The ASU requires plans to disclose the contract value of each type of FBRIC (e.g., traditional or synthetic) and eliminates the following reporting requirements:
  • Measurement and presentation at fair value within the statements of net assets available for benefits
  • Related disclosures required by Topics 820 (Fair Value Measurement) and 825 (Financial Instruments)
  • Certain disclosures under Topics 962 and 965 requiring a fair value calculation (e.g., interest crediting rate and average yield disclosures)

The ASU also clarifies that indirect investments in FBRICs (e.g., stable value common or collective trusts) should no longer be reflected as FBRICs and, therefore, should be reported at fair value. Generally, those funds calculate net asset value per share (NAV) or its equivalent in a manner consistent with the measurement principles of Topic 946 (Financial Services – Investment Companies). As such, those funds may qualify for the NAV practical expedient, which would then permit the funds to be omitted from the fair value hierarchy under ASU 2015-07, Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)
Part II - Plan Investment Disclosures The guidance in Part II of the ASU applies to reporting entities that follow the requirements of Topics 960 (Plan Accounting - Defined Benefit Pension Plans), 962 and 965.
 
Prior to Part II of ASU 2015-12, U.S. GAAP required an entity to disclose the following:

(i) Individual investments that represent 5 percent or more of the net assets available for benefits
(ii) Net appreciation or depreciation for investments by general type of investment
(iii) Investment information disaggregated based on the nature, characteristics and risks

The following reflect the changes adopted under Part II of the ASU:
  • Disclosure requirements (i) and (ii) above are eliminated. However, net appreciation or depreciation in fair value of investments for the period is now required to be presented only in the aggregate. In addition, investments (both participant-directed and nonparticipant-directed) are now required to disaggregate only by general type of investment (e.g., common stocks, corporate bonds, pooled separate accounts, mutual funds, government securities, mortgages, real estate, etc.) either on the face of the financial statements or in the notes. 
  • The ASU removes the requirement to disaggregate the investments within self-directed brokerage accounts. These investments should now be presented as a single type of investment. 
  • For investments measured using NAV as the practical expedient and that also file as a Direct Filing Entity (DFE), the disclosure of the investment’s strategy is no longer required.

Part III – Measurement Date Practical Expedient The guidance in Part III of the ASU applies to reporting entities that follow the requirements of Topics 960, 962 and 965 and have a fiscal year-end that does not coincide with a month-end.
 
Part III permits plans to measure investments and investment-related accounts (for example, a liability for a pending trade with a broker) as of a month-end date that is closest to the plan’s fiscal year-end (the “alternative measurement date”), when the fiscal period does not coincide with a month-end.
 
Plans that apply the practical expedient should disclose the accounting policy election, the alternative measurement date and the amount of any contribution, distribution, and/or significant events that occurs between the alternative measurement date and the plan’s fiscal year-end. A similar measurement date practical expedient is available through ASU 2015-04, Compensation – Retirement Benefits (Topic 715): Practical Expedient for the Measurement Date of an Employer’s Defined Benefit Obligation, for employers with fiscal periods that do not coincide with a month-end.
  Effective Dates The guidance in each part of the new ASU is effective for fiscal years beginning after December 15, 2015, with early adoption permitted for all three parts individually or in the aggregate.

Parts I and II of the ASU should be applied retrospectively, while Part III should be applied prospectively.  Only the nature and reason for the change in accounting principle is required to be disclosed in the annual period of adoption.
Practical Considerations for Implementation While this new guidance is certainly welcomed for the potential time savings gained through eliminated and/or simplified disclosures, there are certain practical considerations to address when implementing.  Some of these considerations include:
 
  • Continue to understand the nature of the plan’s investment contracts (e.g., are the contracts fully benefit-responsive and if so, are the contracts held directly or indirectly by the plan?).
  • Watch for potentially counter-intuitive guidance (for instance, indirect investments in FBRICs may potentially be excluded from the fair value hierarchy, but the path to arrive at that conclusion is circuitous).
  • Consider how the fair value of the investments in the hierarchy will be reconciled to the corresponding line items in the statements of net assets available for benefits (e.g., how will investments no longer required to be included in the fair value hierarchy be addressed?).
  • Be aware of unintentional consequences of adopting this ASU and ensure minimum required disclosures are met. Elimination of disclosures discussed above may result in additional disclosures under other applicable reporting guidance. For example, disaggregation of investments by general type may result in additional disclosures needed regarding investment strategies, which may have been considered adequately disclosed when disaggregated by investment class. Also, if two or more disclosures were previously combined, portions of the original disclosure may still be required. 
  
Changes to the 2015 ERISA Annual Reports (Form 5500) The Summer 2015 edition of the EBP Commentator discussed noteworthy changes to the 2014 ERISA Annual Reports. We wanted to alert sponsors to additional changes anticipated for the 2015 Annual Return/Report of Employee Benefit Plan (Form 5500) and Short Form Annual Return/Report of Small Employee Benefit Plan (Form 5500-SF), based on initial drafts of the 2015 Form 5500 series released in December 2015 by the U.S. Department of Labor (DOL), Internal Revenue Service (IRS) and Pension Benefit Guarantee Corp (PBGC). Some of the more significant changes on the Form 5500 series are highlighted below:
Plan Trust’s Financial Activity Several compliance questions have been added to the 2015 Form 5500 Schedules I and H and Form 5500-SF. While optional for 2015, the IRS nonetheless is encouraging sponsors to answer these questions. Even if a sponsor elects not to respond for 2015, be aware that these questions will likely require additional time and preparation for the 2016 plan filing year when the requirement to answer becomes mandatory.
  • Schedule H and Schedule I, Line 4o and Form 5500-SF, Line 10j ask “Did the plan trust incur unrelated business taxable income during the year?” This question relates to unrelated business income tax (UBIT), which according to IRS Publication 598 means the plan has incurred gross income derived from an unrelated trade or business unrelated to the plan’s exempt purpose within the trust.  Generally, this results from alternative investments within a plan such as partnerships and real estate investments.  UBIT can result in a tax consequence for the normally exempt trust and should be evaluated by an experienced tax professional.  Although the Form 5500 instructions note that Form 990-T, Exempt Organization Business Income Tax Return, is required for gross income of $1,000 or more, there may be additional tax benefits of filing 990-T in years when the gross income is $1,000 or less.  Plan sponsors should consult with their investment and tax advisors when making a determination regarding UBIT and the related tax filing.
  • Form 5500 Schedule H and Schedule I, Line 4p and Form 5500-SF, Line 19 ask “Were in-service distributions made during the plan year?” In-service withdrawals include pre-retirement distributions while actively employed as well as hardship distributions. It also includes amounts withdrawn from a profit sharing plan after a fixed number of years and withdrawals from plans subject to minimum funding including a money purchase plan at age 62 and defined benefit plans. Note the dollar amount of these distributions is required to be reported. 

Additionally, the name of the trustee or custodian of the plan (along with their contact information) has been added to both the Form 5500 and Form 5500-SF series.
Plan Qualification Requirements and Compliance under Internal Revenue Code (Section 6058) Schedule R (Part VII) and Schedule SF (Part IX) asks specific compliance questions related to discrimination testing, including:
  • 401(k) plan testing questions
  • Whether the plan satisfied nondiscrimination requirements
  • Questions related to plan’s favorable determination letter status
  • Updates related to plan amendments
  • Whether the plan is maintained in a U.S. Territory5500-SF also contains an additional question as to whether minimum distributions were made to 5% owners who have attained age 70 ½ (whether or not retired). 

Specifically related to nondiscrimination testing, there is a question regarding which method a 401(k) plan utilized to satisfy the ADP/ACP testing, including the current year testing method and safe harbor designed based methods. Sponsors must also indicate whether the ratio, average benefit test or permissive aggregation was utilized to satisfy 410(b) and 401(a)(4). In regards to plan qualification, the Plan sponsor must indicate whether the plan was timely amended to comply with all required tax law changes, date of the amendment or restatement and applicable code and date of the favorable IRS opinion or determination letter based on the plan document type as pre-approved master and prototype or individually designed. Plan sponsors will need to work closely with their benefits professionals in order to correctly answer these questions.
Form 5500-SUP The IRS has issued 5500-SUP, Annual Return of Employee Benefit Plans Supplemental Information, as a separate filing for the compliance questions that are also covered on the Form 5500 series. Electronic filing of the Form 5500 for plan years beginning on or after January 1, 2015, is required by the IRS for Form 5500 series filers who file at least 250 returns (including Form W-2, corporate returns). Sponsors already meet this requirement since these returns have been required to be filed electronically with the Department of Labor at EFAST2 since 2009. IRS has provided Form 5500-SUP for sponsors who file fewer than 250 tax returns of any type and choose not to answer the IRS compliance questions electronically through the EFAST2 system. However, sponsors will be able to satisfy the compliance filing requirement by answering the new questions on Form 5500 or Form 5500-SF and filing through EFAST2.
Defined Benefit Plans Modifications to Schedule MB include a new question that requires multiemployer defined benefit plans with 500 or more total participants to provide an attachment of projected benefits to be paid over the next ten years, including the current filing year. This specifically applies to plans in critical and declining status. 
 
Schedule SB instructions are modified to simplify the attachment required for cash balance plans with 1,000 or more active participants.  These changes are mandatory for the 2015 filing year and must be answered.

The changes are in addition to the previous revisions to the 2014 Form 5500 so sponsors may need to proof more closely to ensure any mistakes (even seemingly minor ones) are caught before submission. As was noted in the Summer 2015 edition, incorrect filings can expose a plan and/or sponsor to enforcement agency scrutiny and/or penalties.
 
Form 5500 Automatic Extension Timing Remains the Same For those who may have heard of changes to the filing extension available for Form 5500s, the extended deadline has been changed back to 2½ months, which is consistent with current practice.  Section 32104 of the FAST Act repealed the earlier automatic extension of 3 ½ months for filing Form 5500 so plans will have the 2 ½ month automatic extension to file Form 5500 for 2016 and later calendar plan year filings.
 
IRS Announcement 2015-19 - Changes to the Individually Designed Determination Letter Program Effective January 2, 2017, the IRS will eliminate the staggered 5-year remedial amendment cycles for individually designed plans and will no longer accept these determination letter applications. IRS Announcement 2015-19 indicates that individually designed plans will be permitted to submit an application for determination under the following circumstances:
  • Sponsors of Cycle A plans (described in section 9.03 of Rev. Proc. 2007-44) may continue to submit determination letter applications for the period February 1, 2016 - January 1, 2017
  • During the initial plan qualification on Form 5300, Application for Determination for Employee Benefit Plan
  • Qualification upon plan termination 

There have been no changes to the pre-approved master and prototype (M&P) and Volume Submitter plan submissions that generally have a regular, 6-year remedial amendment cycle. 
 
Now Is the Time for a Regulatory Compliance Check For 403(b) Plans Tax-exempt organizations that sponsor 403(b) plans are being advised to check their plans for possible compliance issues since the IRS recently announced that these plans are on its priorities list for 2016. Below are some questions that 403(b) plan sponsors may want to ask their plan management as part of ensuring the plan is compliant before a possible IRS review:       
 
  • Has plan management determined (and documented appropriately) if there is a plan audit requirement?
  • If there is first-time audit requirement, has plan management gathered sufficient documentation to support account balances as of the beginning of the plan year?
  • Did the organization report a pension contribution on the Form 990?  If there is no associated Form 5500 filing for the pension plan, then this may be a red flag of a possible missed audit.
  • Does the plan have a formal (e.g., written) plan document?  Do the plan’s day-to-day activities conform to what the plan document stipulates?  This is one of most common operational errors BDO encounters, regardless of the plan type.  Simply put, the terms of the plan need to agree to what is offered by the sponsor in operation. If there are differences, consider whether consultation and corrective action may be needed.   
  • Does the plan have an advisor who regularly is involved in review of the plan document, features, investments offered, etc.?  Plan sponsors who lack the internal expertise can benefit from using a provider with the requisite knowledge and expertise, provided that the sponsor maintains both continued oversight over the plan and good communication with the provider.     

In our opinion, compliance checks are not a “one and done” activity, but rather a recurring part of the sponsor’s annual process that demonstrates good governance practices and a strong commitment to proper fiduciary responsibility.  
 
Update on DOL “Conflict-of-Interest” Fiduciary Rule The omnibus spending bill passed by Congress in December 2015 was notable in that it did not contain any language to “defund” the conflict-of-interest rule. The fiduciary rule has been subject to previous legislative attempts to prohibit the use of funds to implement, administer or enforce the proposed definition of the term “Fiduciary” under the DOL’s proposed regulation. Based on this latest development, some predict it is likely that the fiduciary rule will survive and ultimately be implemented, although others suggest that it will be subject to continued challenges. 
 
Noteworthy for ESOPs  Under IRS Revenue Procedure 2015-36, the IRS will permit employee stock ownership plans (ESOPs) that meet certain requirements to qualify for pre-approval for initial and cyclical letters of determination if the ESOP adopts a prototype plan or volume submitter plan.

Also, the DOL has indicated that it will remove a component of the revised fiduciary rule proposal that addresses whether ESOP valuation advisors are considered fiduciaries. (Stay tuned as this hotly contested issue is expected to be addressed in a separate regulatory initiative.) 
 
Do You Have Questions about Your Role as Plan Fiduciary?  If so, join us for a plan sponsor-focused webinar series.  
Fiduciary Gridiron – How to Succeed on the Field is a four-part webinar series for plan sponsors that tackles some of the common challenges and responsibilities facing plan management when dealing with their fiduciary responsibility. The Q&A discussion format provides a three-fold perspective from the panelists, consisting of an attorney specializing in ERISA plans, an experienced plan advisor and one of our own EBP auditors.  
 
Part One – Selecting Your Retirement Plan Team addresses who should be involved in the plan and the critical EBP team selection process. The webinar addresses the role of fiduciaries, the number of fiduciaries required to be named in a plan, best practices in carrying out fiduciary responsibilities, and how prudent processes can help mitigate fiduciary liability. Panelists discuss the importance of sponsors understanding that ERISA requires fiduciaries to act as prudent experts and suggest some potential ways sponsors can minimize their liability. The webinar then delves into required versus optional plan service providers, approaches for evaluating service providers, and trends in service provider compensation methods. If you missed the webinar (held May 2015), the recording is available here.

In Part Two – Kicking Off the Season, the panelists discuss the best practices of having a plan committee, recommended documentation to help mitigate liability for plan committees and insight on who should be on a plan committee. The webinar also outlines best practices as to what and how much information to document within an investment policy statement. Topics also include: trends in plan designs (including auto enrollment and auto escalation), the “right” number of investments, who is monitoring plans, and critical factors to ensuring plans are compliant. Panelists provide their thoughts on sponsors offering professional advisors to participants and the potential added responsibilities of providing this benefit. This webinar also provides an overview of fees, fee benchmarking, allocation of fees to participants, and the use of revenue sharing agreements. To listen to the August 2015 recording, go here.

Part Three - Push for the Playoffs continues the focus on plan fees with a discussion of fee allocation, revenue sharing, and plan investments. Panelists weigh in on the types of fees that can generally be paid from plan assets, best practices in assessing the reasonableness of plan fees, and why plan fees should be reviewed. The discussion also includes the various methods used to pay plan fees (including revenue sharing, pro rata, and per capita). Trends and illustrations of fee structures are reviewed to assist sponsors in understanding the process of analyzing fees. The panelists consider investment share classes and how these classes can impact plan performance. Best practices on the timing of reviewing investments, documenting the investment monitoring process, and investment policy statements conclude the discussion.  The recording from the November 2015 webinar is available here.

Part Four – On The Road to the Championship will be held on January 21, 2016 (12:30 p.m. ET).  This webinar will focus on ensuring plan management is ready to meet enforcement guidelines. Discussion will focus on the latest news from the DOL and the IRS as well as how to prepare for a plan audit and suggested best practices for plan operations. Register for this upcoming webinar here.
 
Contact Bob Lavenberg
Assurance Partner
National Partner in Charge of Employee Benefit Plan Audit Quality
(215) 636-5576 / rlavenberg@bdo.com
 

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