The Cooperative Accountant - Spring 2024

3 From the Editor

By Frank M. Messina,

DBA, CPA

4 Utility Cooperative Forum: "Customer First" is the Ultimate Goal of Process Improvements

By Peggy

Maranan, CPA, MBA, Ph.D.

9 ACCTFAX Bulletin Board

By Editor

Greg Taylor,

MBA, CPA, CVA

29 TAXFAX

By Editor George W. Benson; David F. Antoni, CPA; Christopher H. Hanna, JD, LLM; & Eric Krienert, CPA

40 Small Business Forum: 2023 NCFC Legal, Tax and Accounting Subcommittee Reports FASB Update –Selected Sections

By Editor Barbara A. Wech, Ph.D.; 2023 NCFC Legal, Tax and Accounting Subcommittee Reports FASB Update –Selected Sections

From the Editor

Frank M. Messina, DBA, CPA Alumni & Friends Endowed Professor of Accounting UAB Department of Accounting & Finance

CSB 319, 710 13th Street South Birmingham, AL 35294-1460 • (205) 934-8827 fmessina@uab.edu

It is so easy these days to feel like you are a voice crying out into the desert. When it seems like no one is listening to you, it’s easy to feel unimportant, frustrated, and lonely. Yelling, screaming and fussing are not the right solution. Do your best to properly communicate your feelings in a professional manner. Good communication can make the difference between confident, motived employees and an unproductive team with low morale. It builds thriving relationships and gives people the information they need to contribute to the success of the cooperative. What are good communication methods? Just google and you will find many. However they all seem to revolve around the basics in life – oral, written, non-verbal communication and active listening. In this social media and cell phone world many of these basics are being lost. Make it a point to work on these!

Remember, we too are always looking for you to share your knowledge since you may have some extra time on your hands (like others continue to do) with us through articles in The Cooperative Accountant. Feel free to contact me (fmessina@uab.edu) if you have any ideas or thoughts on a potential article contribution. Sharing knowledge is a wonderful thing for all!!! Knowledge can change our world!

That is why we must remember – “The Past is history; the Future is a mystery, but this Moment is a Gift – that’s why it’s called the Present.”

Positively Yours,

Frank M. Messina, DBA, CPA

Articles and other information which appear in The Cooperative Accountant do not necessarily reflect the official position of the NATIONAL SOCIETY OF ACCOUNTANTS FOR COOPERATIVES and the publication does not constitute an endorsement of views or information which may be expressed.

The Cooperative Accountant (ISSN 0010-83910) is published quarterly by the National Society of Accountants for Cooperatives at Centerville, Ohio 45459 digitally. The Cooperative Accountant is published as a direct benefit/ service to the members of the Society and is only available to those that are eligible for membership. Subscriptions are available to university libraries, government agencies and other libraries. Land Grant colleges may receive a digital copy. Send requests and contact changes to: The National Society of Accountants for Cooperatives, 7946 Clyo Road, Suite A, Centerville, Ohio 45459.

Customer-centric finance departments

Expectations for finance departments are increasing. Processes are becoming more complex. Regulations continue to increase. Those that rely on financial information to perform key business tasks are demanding the ability to make faster decisions. The finance department needs to keep changing and improving to keep up with these expectations. Efficiency and process improvement are a necessity because the department just can’t keep adding costs. A finance department is an integral part of the cooperative as a support service for managing all financial processes and decisions. It controls income and expenditures while also ensuring the business is operating under financially sound practices. Some of the key functions that a finance department fulfills include procure-to-pay, order-to-cash, treasury management, financial planning and analysis, tax reporting, accounting and financial reporting, payroll processing, and strategic planning support.

While the ultimate “customer” of a cooperative is its members and those that benefit from its products and services, there are many other internal and external “customers” that a finance department serves. Consumers of information produced by a finance department exist internally within the cooperative in almost every area or department of an organization due to the key role that finance plays. Additionally, outside customers can include vendors, regulators, governmental agencies, and taxing authorities. Customer success is about ensuring customers are deriving real value from the support received from their finance department team members. Value is measured in determining whether those served by the finance department are benefitting from their interactions with the finance team and perceive their interactions to be positive experiences. Customer success is a mindset of constant evolution, constantly and proactively determined to achieve improvement.

The challenge remains that all financial

departments contain some waste and inefficiency at any given time. A continuous process improvement mindset will help to address this and set the tone for evaluating areas where inefficiencies can be found. Some of the inefficiencies that could exist might include incomplete or inaccurate information being provided from the start of the process, rekeying of data between disparate systems, correcting or reworking previous errors, waiting for necessary approvals, insufficient reporting capabilities, and lack of automation eliminating wasteful manual tasks.

Campos (2023) defines an accounting process improvement as “the practice of refining your existing workflows to increase your department’s efficiency” (para. 2). Campos contends that improvements can typically involve the use of technology to achieve goals frequently desired by finance departments. Some of these goals might include:

• Automate manual, repetitive and timeconsuming tasks.

• Free up the time of your in-house accounting staff. This way, they can focus on other higher-level, urgent accounting duties.

• Provide data-backed insights to decisionmakers.

• Prevent manual data entry errors.

• Fast-track the turnaround time for completing projects.

• Create a formalized set of guidelines to assist each team member to adopt the new processes. (para. 2)

Some of the process improvements popularly being considered include:

• Providing sufficient training of staff, including the creation and continuous update of written procedures

• Using cloud accounting solutions

• Implementing of data analytics tools

• Asking staff for feedback for their opinions and suggestions

• Assessing and re-assessing processes continuously

• Using a project management software or protocol to assist with managing and implementing process improvements

• Standardizing accounting processes

• Outsourcing accounting tasks where it can add value or address staff capacity limitations

• Implement software strategically designed to support process efficiencies

Hoskins and Moore of KPMG (2023) note that “Transformation is no longer a choice for businesses. It is a necessity.” (p. 2). They suggest that there are four organizational capabilities needed in order for companies to manage continuous transformation:

1) Tracking value – measure and quantify impacts to transformation.

2) Building roadmaps – break down the strategic vision into quick, measurable outcomes and prioritize them into sequences of releases based upon potential value.

3) Orchestrating multiple initiatives –organizations need to manage many moving parts and evolving goals of multiple, simultaneous initiatives and ensure connectivity across programs, being careful not to force unnecessary conformity.

4) Guiding people on the journey –transformation can cause stress to people and organizational culture. It is important to obtain buy-in from those involved and manage people’s capacity for change. Communication and training at the individual improvement level is key to achieving success. (p. 4-6)

Emerging technologies

Heffernan (2021) notes that robotic process

automation (RPA) and robotic desktop automation (RDA) have been emerging tools ideal for automating repetitive tasks and freeing up staff time for other value-added activities. RPA runs without human interaction whereas RDA runs with human interaction. For example, RPA can allow a finance team member to look up data in one place, for instance a bank statement, and then enter it into another place or system such as an enterprise resource planning (ERP) system. In an accounts payable process, RPA can use optical character recognition technology to automate invoice entry as well as making decisions to route as an exception to a human for further decisions for processing. Intelligent automation (IA) is an even more advanced version of RPA, having the ability to introduce more sophisticated implied meanings in communications. IA can use historical data to adapt its ability over time to take actions a human might take whereas RPA is more rules-based.

Artificial intelligence (AI) and machine learning (ML) have also been emerging technologies that have been enhancing efficiencies. These are considered cognitive computing applications. Cognitive computing involves the use of computer models to simulate human thought processes. Examples of some of the applications include monitoring coding of invoices or journal entries to identify possible incorrect coding based upon historical transactions. Another example of the use of AI includes “reading” contracts to extract key information necessary for revenue recognition or lease accounting. AI and ML have been very effective tools to prevent errors by providing the ability to electronically scan large volumes of transactions and find instances that

appear to be outliers, not following historical patterns, which might need further human investigation or resolution.

Blockchain has also been another emerging technology. Blockchain is “a public ledger capable of recording the origin, movement and transfer of anything of value” (Urwin, 2023, para. 2). One of the most significant applications of blockchain technology is in streamlining payment systems. Other applications of blockchain in the finance arena include simplified payment processing, loyalty and rewards programs, upgraded digital identity management, smart contracts, and advanced trading and investment capabilities. Other areas where blockchain has been implemented to support process efficiencies include “intercompany transactions (when there are multiple ERPs), procure-to-pay, order-to-cash, rebates, warranties, and financing (such as trade finance, letters of credit, and invoice factoring)” (Deloitte, 2019, “What blockchain does” section, para. 1).

Some other options targeted specifically for finance functions include computer software programs designed for process efficiency in managing key finance processes. These include programs such as those designed for the month-end close process, account reconciliations, task management, accounts payable activities, procurement vendor portal management, reporting solutions, document management, practice management and workflow, and journal entry automation. The key to a successful process improvement in deploying any of these is to find the best fit for your organization. Not all solutions are the best for your company, and there needs to be consideration for how they will integrate and enhance existing processes.

So where does one start?

Kissflow (2023) recommends starting with an audit of your finance function (para. 13). They recommend identifying areas for improvement that might offer the business the most significant gains, and not trying to tackle everything at once.

CFO Selections Team (2022) recommends focusing improvements on “high-risk work” (para. 9). They define this as work that can have serious financial implications if it is done improperly. One caution is to use technology or automation improvement strategically, for improvements that add real value and not just for the sake of implementing new technology. Collins (2019) cites the American Productivity & Quality Center (APQC) as recommending that “organizations focus first on understanding, standardizing, and streamlining their processes in order to maximize the return on their automation efforts” (para. 7). Heffernan recommends beginning by identifying the frequency and root cause of inefficiencies that will lead to the greatest gains if process improvements are implemented. One of the keys to success is establishing target measurements for improvements so that the end goal is clear and successful implementation can be measured against those targets. Ideally, any finance department would like to achieve similar goals. Maynard (n.d.) indicates that those goals might include:

• Finance processes focused on the customer and designed to meet specific customer expectations

• Work completed right the first time, without a need for backtracking or requesting additional information

• Information flowing through the processes with few interruptions and little backtracking or double-checking

• Timely, relevant and accurate information that is understandable by the end-user

for decision making

• Supporting the resolution of process problems (Slide 5)

Factors to consider deploying when approaching a process improvement assessment include process roadmaps, governance models, change management plans, and key performance metrics. It is also important for success to be known. Whether the improvement results in a small or big win, let others know of the success so that the entire team will be uplifted by the accomplishments of the group.

Processes are improved by people working together. The people in any process are in the best position to understand problems and constraints, and drive solutions. Improvement is the responsibility of the finance department team, and departmental managers are facilitators by providing the support necessary for success. The important questions to ask include:

1) Who are the customers of the process, and what do they need?

2) How does the process currently work? Where do the delays, risk points and errors arise?

3) How can we improve the process, and reduce the risk of errors and delays?

(Maynard, Slide 7)

Some processes that may beg for improvement include those that are run frequently, take a fair amount of time to complete if done manually, use data from several sources, contain information that is valuable for audit, contain many steps to complete, can change over time, have a high risk of human error, or have a key person dependency.

The following includes a checklist of some of the functional processes that might be considered for process improvement.

UTILITY COOPERATIVE FORUM

While this list is not all inclusive, it provides a comprehensive listing of areas to be identified that might benefit from process improvement.

• Accounts payable

• Expense reimbursement process

• Accounts receivable

• Payroll

• Compensation and benefits administration

• General ledger account reconciliations

• Financial reporting

• Financial close process

• Budgeting

References

• Budget vs. Actual reporting

• Purchasing

• Vendor relationship management

• Auditing

• Treasury and cash management

• Regulatory reporting

• Policy compliance

• Tax compliance and reporting

• Administrative-related tasks

• Any manual or repetitive accounting tasks

• Workflow and approval processes

• Document retrieval and management

Campos, M. (April 12, 2023). Accounting Process Improvement: How to Reduce Inefficiencies. Retrieved February 14, 2024 from the following website: https:// www.dvphilippines.com/blog/accounting-process-improvement-4-ideas-to-reduceinefficiency#:~:text=Accounting%20process%20improvement%20is%20the,your%20 in%2Dhouse%20accounting%20professionals.

CFO Selections Team. (July 7, 2022). Faster or better? How to truly improve your accounting processes. Retrieved February 14, 2024 from the following website: https:// www.cfoselections.com/perspective/faster-or-better-how-to-truly-improve-youraccounting-processes

Collins, R. (October 25, 2019). 6 Practices shrewd finance departments do to improve process performance. Retrieved February 14, 2024 from the following website: https:// www.apqc.org/blog/six-ways-improve-your-general-accounting-process-performance

Deloitte. (March 2019). CFO Insights: Unleashing blockchain in finance. Retrieved February 14, 2024 from the following website: https://www2.deloitte.com/us/en/pages/ finance/articles/unleashing-blockchain-in-finance.html

Heffernan, L. (October 1, 2021). Process Improvements in Accounting. Retrieved February 14, 2024 from the following website: https://www.sfmagazine.com/articles/2021/october/ process-improvements-in-accounting/

Hoskins, P. & Moore, T. (2023). The art of continuous transformation. KPMG. Retrieved February 14, 2024 from the following website: https://kpmg.com/us/en/articles/2023/ art-continuous-transformation.html?utm_source=google&utm_medium=cpc&utm_ campaign=7014W000001j747QAA&cid=7014W000001j747QAA&gad_

By Greg Taylor

FASB ISSUES ASU 2023-08 December 2023 INTANGIBLES – GOODWILL AND OTHER – CRYPTO ASSETS (SUBTOPIC 350-60)

Accounting for the Disclosure of Crypto Assets

Summary

Why Is the FASB Issuing This Accounting Standards Update (Update)?

The Board is issuing the amendments in this Update to improve the accounting for and disclosure of crypto assets. Stakeholder feedback, including from respondents to the 2021 FASB Invitation to Comment (ITC), Agenda Consultation, indicated that improving the accounting for and disclosure of crypto assets should be a top priority for the Board. Stakeholders stated that the current accounting—except as provided in generally accepted accounting principles (GAAP) for certain specialized industries—for holdings of crypto assets as indefinite-lived intangible assets, which is a cost-less-impairment accounting model, does not provide investors, lenders, creditors, and other allocators of capital (collectively, “investors”) with decision-useful information. Specifically, accounting for only the decreases, but not the increases, in the value of crypto assets in the financial statements until they are sold does not provide relevant information that reflects (1) the underlying economics of those assets and

(2) an entity’s financial position. Investors also requested additional disclosures about the types of crypto assets held by entities and the changes in those holdings. In addition to better reflecting the economics of crypto assets, measuring those assets at fair value will likely reduce cost and complexity associated with applying the current costless-impairment accounting model for many entities.

Who Is Affected by the Amendments in This Update?

The amendments in this Update apply to all entities holding assets that meet certain scope criteria.

What Are the Main Provisions?

The amendments in this Update apply to assets that meet all of the following criteria:

1. Meet the definition of intangible assets as defined in the Codification

2. Do not provide the asset holder with enforceable rights to or claims on underlying goods, services, or other assets

3. Are created or reside on a distributed ledger based on blockchain or similar technology

4. Are secured through cryptography

5. Are fungible

6. Are not created or issued by the reporting entity or its related parties.

ACCTFAX

An entity is required to subsequently measure assets that meet those criteria at fair value with changes recognized in net income each reporting period. The amendments in this Update also require that an entity present (1) crypto assets measured at fair value separately from other intangible assets in the balance sheet and (2) changes from the remeasurement of crypto assets separately from changes in the carrying amounts of other intangible assets in the income statement (or statement of activities for notfor-profit entities). While the amendments in this Update do not otherwise change the presentation requirements for the statement of cash flows, the amendments require specific presentation of cash receipts arising from crypto assets that are received as noncash consideration in the ordinary course of business (or as a contribution, in the case of a not-for-profit entity) and are converted nearly immediately into cash. For annual and interim reporting periods, the amendments in this Update require that an entity, including an entity that is subject to industry-specific guidance, disclose the following information:

1. The name, cost basis, fair value, and number of units for each significant crypto asset holding and the aggregate fair values and cost bases of the crypto asset holdings that are not individually significant

2. For crypto assets that are subject to contractual sale restrictions, the fair value of those crypto assets, the nature and remaining duration of the restriction(s), and the circumstances that could cause the restriction(s) to lapse.

For annual reporting periods, the amendments in this Update require that an entity disclose the following information:

1. A rollforward, in the aggregate, of activity in the reporting period for crypto asset holdings, including additions (with a description of the activities that resulted in the additions), dispositions, gains, and losses

2. For any dispositions of crypto assets in the reporting period, the difference between the disposal price and the cost basis and a description of the activities that resulted in the dispositions

3. If gains and losses are not presented separately, the income statement line item in which those gains and losses are recognized

4. The method for determining the cost basis of crypto assets.

How Do the Main Provisions Differ from Current Generally Accepted

Accounting Principles (GAAP) and Why Are They an Improvement?

Under current GAAP, unless otherwise provided in industry-specific GAAP, crypto assets that are within the scope of the amendments in this Update are accounted for as indefinite-lived intangible assets. Those assets are tested for impairment annually and more frequently if events or circumstances indicate that it is more likely than not that an asset is impaired. If the carrying amount of the asset exceeds its fair value, an entity is required to recognize an impairment loss and reduce the carrying amount of the asset to its fair value. Subsequent increases in the carrying amount of the asset and reversal of an impairment loss are prohibited. The amendments in this Update require that an entity measure crypto assets at fair value in the statement of financial position each reporting period and recognize changes from remeasurement in net income. The amendments also require that an entity provide enhanced disclosures for both annual and interim reporting periods to provide investors with relevant information to analyze and assess the exposure and risk of significant individual crypto asset holdings.

In addition, fair value measurement aligns the accounting required for holders of crypto assets with the accounting for entities

that are subject to certain industry-specific guidance (such as investment companies) and eliminates the 4 requirement to test those assets for impairment, thereby reducing the associated cost and complexity of applying the current guidance.

When Will the Amendments Be Effective and What Are the Transition Requirements?

The amendments in this Update are effective for all entities for fiscal years beginning after December 15, 2024, including interim periods within those fiscal years. Early adoption is permitted for both interim and annual financial statements that have not yet been issued (or made available for issuance). If an entity adopts the amendments in an interim period, it must adopt them as of the beginning of the fiscal year that includes that interim period.

The amendments in this Update require a cumulative-effect adjustment to the opening balance of retained earnings (or other appropriate components of equity or net assets) as of the beginning of the annual reporting period in which an entity adopts the amendments.

The ASU, including effective date information, is available at www.fasb.org

FASB ISSUES ASU 2023-09 December 2023 INCOME TAXES (TOPIC 740)

Improvements to Income Tax Disclosures

Summary

Why Is the FASB Issuing This Accounting Standards Update (Update)?

The Board is issuing the amendments in this Update to enhance the transparency and decision usefulness of income tax disclosures. Investors, lenders, creditors, and other allocators of capital (collectively, “investors”) indicated that the existing income tax disclosures should be enhanced to provide information to better assess

how an entity’s operations and related tax risks and tax planning and operational opportunities affect its tax rate and prospects for future cash flows. Investors currently rely on the rate reconciliation table and other disclosures, including total income taxes paid, to evaluate income tax risks and opportunities. While investors find these disclosures helpful, they suggested possible enhancements to better (1) understand an entity’s exposure to potential changes in jurisdictional tax legislation and the ensuing risks and opportunities, (2) assess income tax information that affects cash flow forecasts and capital allocation decisions, and (3) identify potential opportunities to increase future cash flows.

The amendments in this Update address investor requests for more transparency about income tax information through improvements to income tax disclosures primarily related to the rate reconciliation and income taxes paid information.

This Update also includes certain other amendments to improve the effectiveness of income tax disclosures.

Who Is Affected by the Amendments in This Update?

The amendments in this Update apply to all entities that are subject to Topic 740, Income Taxes. Certain disclosures that are required by the amendments in this Update are not required for entities other than public business entities.

What Are the Main Provisions? Rate Reconciliation

The amendments in this Update require that public business entities on an annual basis (1) disclose specific categories in the rate reconciliation and (2) provide additional information for reconciling items that meet a quantitative threshold (if the effect of those reconciling items is equal to or greater than 5 percent of the amount computed by

multiplying pretax income [or loss] by the applicable statutory income tax rate). Specifically, public business entities are required to disclose a tabular reconciliation, using both percentages and reporting currency amounts, according to the following requirements:

1. The following specific categories are required to be disclosed:

a. State and local income tax, net of federal (national) income tax effect

b. Foreign tax effects

c. Effect of changes in tax laws or rates enacted in the current period

d. Effect of cross-border tax laws

e. Tax credits

f. Changes in valuation allowances

g. Nontaxable or nondeductible items

h. Changes in unrecognized tax benefits.

2. Separate disclosure is required for any reconciling item listed below in which the effect of the reconciling item is equal to or greater than 5 percent of the amount computed by multiplying the income (or loss) from continuing operations before income taxes by the applicable statutory income tax rate.

a. If the reconciling item is within the effect of cross-border tax laws, tax credits, or nontaxable or nondeductible items categories, it is required to be disaggregated by nature.

b. If the reconciling item is within the foreign tax effects category, it is required to be disaggregated by jurisdiction (country) and by nature, except for reconciling items related to changes in unrecognized tax benefits discussed in (4).

c. If the reconciling item does not fall within any of the categories listed in (1), it is required to be disaggregated by nature.

3. For the purpose of categorizing reconciling items, except for reconciling items related to changes in unrecognized tax benefits discussed in (4), the state and local income tax category should reflect income taxes

imposed at the state or local level within the jurisdiction (country) of domicile, the foreign tax effects category should reflect income taxes imposed by foreign jurisdictions, and the remaining categories listed in (1) should reflect federal (national) income taxes imposed by the jurisdiction (country) of domicile.

4. For the purpose of presenting reconciling items:

a. Reconciling items are required to be presented on a gross basis with two exceptions under which unrecognized tax benefits and the related tax positions and tax effects of certain cross-border tax laws and the related tax credits may be presented on a net basis.

b. Reconciling items presented in the changes in unrecognized tax benefits category may be disclosed on an aggregated basis for all jurisdictions.

For the state and local category, a public business entity is required to provide a qualitative description of the states and local jurisdictions that make up the majority (greater than 50 percent) of the effect of the state and local income tax category.

A public business entity is required to provide an explanation, if not otherwise evident, of the individual reconciling items disclosed, such as the nature, effect, and underlying causes of the reconciling items and the judgment used in categorizing the reconciling items.

For entities other than public business entities, the amendments in this Update require qualitative disclosure about specific categories of reconciling items and individual jurisdictions that result in a significant difference between the statutory tax rate and the effective tax rate.

Income Taxes Paid

The amendments in this Update require that all entities disclose on an annual basis the

following information about income taxes paid:

1. The amount of income taxes paid (net of refunds received) disaggregated by federal (national), state, and foreign taxes

2. The amount of income taxes paid (net of refunds received) disaggregated by individual jurisdictions in which income taxes paid (net of refunds received) is equal to or greater than 5 percent of total income taxes paid (net of refunds received).

Other Disclosures

The amendments in this Update require that all entities disclose the following information:

1. Income (or loss) from continuing operations before income tax expense (or benefit) disaggregated between domestic and foreign

2. Income tax expense (or benefit) from continuing operations disaggregated by federal (national), state, and foreign.

The amendments in this Update eliminate the requirement for all entities to (1) disclose the nature and estimate of the range of the reasonably possible change in the unrecognized tax benefits balance in the next 12 months or (2) make a statement that an estimate of the range cannot be made.

The amendments in this Update remove the requirement to disclose the cumulative amount of each type of temporary difference when a deferred tax liability is not recognized because of the exceptions to comprehensive recognition of deferred taxes related to subsidiaries and corporate joint ventures.

The amendments in this Update replace the term public entity as currently used in Topic 740 with the term public business entity as defined in the Master Glossary of the Codification.

How Do the Main Provisions Differ from Current Generally Accepted Accounting Principles (GAAP)

and Why Are They an Improvement?

The amendments in this Update related to the rate reconciliation and income taxes paid disclosures improve the transparency of income tax disclosures by requiring (1) consistent categories and greater disaggregation of information in the rate reconciliation and (2) income taxes paid disaggregated by jurisdiction. The amendments allow investors to better assess, in their capital allocation decisions, how an entity’s worldwide operations and related tax risks and tax planning and operational opportunities affect its income tax rate and prospects for future cash flows.

The other amendments in this Update improve the effectiveness and comparability of disclosures by (1) adding disclosures of pretax income (or loss) and income tax expense (or benefit) to be consistent with U.S. Securities and Exchange Commission (SEC) Regulation S-X 210.4-08(h), Rules of General Application—General Notes to Financial Statements: Income Tax Expense, and (2) removing disclosures that no longer are considered cost beneficial or relevant.

When Will the Amendments Be Effective and What Are the Transition Requirements?

For public business entities, the amendments in this Update are effective for annual periods beginning after December 15, 2024. For entities other than public business entities, the amendments are effective for annual periods beginning after December 15, 2025.

Early adoption is permitted for annual financial statements that have not yet been issued or made available for issuance.

The amendments in this Update should be applied on a prospective basis. Retrospective application is permitted.

The ASU, including effective date information, is available at www.fasb.org

FASB ISSUES an Exposure Draft

PROPOSED STATEMENT OF FINANCIAL ACCOUNTING CONCEPTS

Concepts Statement No. 8, Conceptual Framework for Financial Reporting –Chapter 6: Measurement (December 21, 2023, No. 2023-ED700)

Measurement

S2. This chapter sets forth concepts on how items recognized in financial statements should be measured and provides guidance on when a specific measurement system should be applied.

S3. Measurement is anchored in prices— both entry prices and exit prices. Prices objectively measure the financial effects of transactions and other events and circumstances on the reporting entity and, consequently, are fundamental in depicting recognized items in general purpose financial reporting.

S4. This chapter describes two relevant and representationally faithful measurement systems: the entry price system and the exit price system. The prices in those measurement systems are defined as follows:

a. Entry price: The price paid (the value of what was given up) to acquire an asset or received to assume a liability in an exchange transaction

b. Exit price: The price received (the value of what was received) to sell an asset or paid to transfer or settle a liability in an exchange transaction.

S5. The conceptual premise in any measurement system is that the reported amounts of assets should not be more than what is recoverable, by disposition or use, and the reported amount of liabilities should not be less than what is settleable, by transfer or satisfaction. A measurement amount that does not meet

the recoverability or settleability premise provides less predictive or confirmatory value and, consequently, yields less relevant financial information.

S6. Choosing between the entry price system and the exit price system should be guided by whichever system best meets the objective of general purpose financial reporting for a particular asset or liability being measured. Determining which measurement system is more relevant depends on the asset or liability itself and how that asset or liability is used or settled.

Questions for Respondents

S7. The Board invites individuals and organizations to comment on all matters in this Exposure Draft, particularly on the questions below. Comments are requested from those who agree with the proposed concepts as well as from those who do not agree. Comments are most helpful if they identify and clearly explain the issue or question to which they relate. Those who disagree with the proposed concepts are asked to describe their suggested alternatives, supported by specific reasoning.

Question 1: Do you agree with the proposed underlying premise that to have predictive value the reported amounts of assets should not be more than what is recoverable, by disposition or use, and the reported amounts of liabilities should not be less than what is settleable, by transfer or satisfaction? Please explain why or why not.

Question 2: Do you agree that measurement is anchored in prices, as described in paragraphs M5 and M6? Do you also agree that transactions and other events and circumstances affecting the entity should ultimately be measured in prices (entry prices

and exit prices)? Please explain why or why not.

Question 3: Do you agree with the proposed description and features of the entry price system as described in paragraphs M10–M14? Please explain why or why not.

Question 4: Do you agree with the proposed description and features of the exit price system as described in paragraphs M15–M19? Please explain why or why not.

Question 5: Do you agree that the entry price and exit price systems, as explained in paragraph M7, are the only two relevant and representationally faithful measurement systems that would meet the objective of general purpose financial reporting? Please explain why or why not.

Question 6: Do you agree that the entry price system would likely result in more relevant measurements when entities have unique exit prices for the same asset or liability? Please explain why or why not. (See paragraph M31.)

Question 7: Do you agree that the exit price system (specifically, an exit price that incorporates market participant cash flows) would likely result in more relevant measurements when entities have the same exit price for the same asset or liability? Please explain why or why not. (See paragraph M32.)

The ED, including explanatory paragraphs referred to above, is available at www.fasb. org

FASB ISSUES an Exposure Draft

DEBT – DEBT WITH

Summary and Questions for Respondents Why Is the FASB Issuing

This Proposed Accounting Standards Update (Update)?

The Board is issuing this proposed Update to improve the application and relevance of the induced conversion guidance in Subtopic 470-20, Debt—Debt with Conversion and Other Options.

When the terms of a convertible debt instrument are changed to induce conversion of the instrument, current generally accepted accounting principles (GAAP) provide guidance for determining whether the transaction should be accounted for as an induced conversion (as opposed to a debt extinguishment). The induced conversion guidance was written in the context of share-settled convertible debt before cash convertible instruments became prevalent in the marketplace. That fact, as well as amendments to the accounting for convertible debt instruments with cash conversion features made by Accounting Standards Update No. 2020-06, Debt— Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity, has resulted in questions from stakeholders about how to determine whether a settlement of convertible debt (particularly cash convertible instruments) at terms that differ from the original conversion terms should be accounted for under the induced conversion or extinguishment guidance.

Who Would Be Affected by the Amendments in This Proposed Update?

AND

OPTIONS (Subtopic 470-20, No. 2023-ED600)

The amendments in this proposed Update would affect entities that settle convertible debt instruments for which the conversion privileges were changed to induce conversion.

ACCTFAX

What Are the Main Provisions, How Would the Main Provisions Differ from Current Generally Accepted Accounting Principles (GAAP), and Why Would They Be an Improvement?

Under current GAAP, the guidance on induced conversions applies only to conversions that include the issuance of all equity securities issuable pursuant to the conversion privileges provided in the terms of the debt at issuance. Current GAAP does not address how this criterion should be applied to the settlement of a convertible debt instrument that does not require the issuance of equity securities upon conversion (for example, a convertible debt instrument with a cash conversion feature). Current GAAP also does not address how the incorporation, elimination, or modification of a volume-weighted average price (VWAP) formula interacts with this criterion, including when such changes could result in the holder receiving less cash or fewer shares than if the debt instrument had been settled in accordance with the conversion privileges provided in the terms of the instrument (prior to any changes to induce conversion). Stakeholders also have noted that, under current GAAP, it is not clear whether the guidance on induced conversions can be applied to the settlement of a convertible debt instrument that is not currently convertible.

The amendments in this proposed Update would clarify the requirements for determining whether certain settlements of convertible debt instruments should be accounted for as an induced conversion. Under the proposed amendments, to account for a settlement of a convertible debt instrument as an induced conversion, an inducement offer would be required to provide the debt holder with, at a minimum, the consideration (in form and amount) issuable under the conversion privileges provided in the terms of the instrument. An

entity would assess whether this criterion is satisfied as of the date the inducement offer is accepted by the holder. If, when applying this criterion, the convertible debt instrument had been modified (without being deemed substantially different) within the one-year period leading up to the offer acceptance date, then an entity would compare the terms provided in the inducement offer with the terms that existed one year before the offer acceptance date. The proposed amendments would not change the other existing criteria that are required to be satisfied to account for a settlement transaction as an induced conversion.

The amendments in this proposed Update also would make additional clarifications to assist stakeholders in applying the proposed guidance. Under the proposed amendments, the incorporation, elimination, or modification of a VWAP formula would not automatically cause a settlement to be accounted for as an extinguishment; an entity would instead assess whether the form and amount of conversion consideration are preserved (that is, provided for in the inducement offer) using the fair value of an entity’s shares as of the offer acceptance date. The amendments in this proposed Update also would clarify that the induced conversion guidance can be applied to a convertible debt instrument that is not currently convertible so long as it had a substantive conversion feature as of its issuance date and is within scope of the guidance in Subtopic 470-20.

What Are the Transition Requirements and When Would the Amendments Be Effective?

The amendments in this proposed Update would permit an entity to apply the new guidance on either a prospective or a retrospective basis.

Under the prospective transition approach, an entity would apply the amendments in this proposed Update to any settlements of

convertible debt instruments that occur after the effective date of the guidance.

Under the retrospective transition approach, an entity would recast prior periods and recognize a cumulative-effect adjustment to equity as of the later of the following dates: (1) the beginning of the earliest period presented and (2) the date the entity adopted the amendments in Update 2020-06. That is, an entity would not be permitted to apply the amendments in this proposed Update retrospectively to settlements that occurred prior to the adoption of the amendments in Update 2020-06 (including settlements occurring within periods that were recast retrospectively under the full retrospective transition approach permitted by Update 2020-06).

The effective date and whether early application should be permitted will be determined after stakeholder feedback on this proposed Update has been considered.

The ED, including questions for respondents, is available at www.fasb.org

RECENT ACTIVITIES OF THE PRIVATE COMPANY COUNCIL

The Private Company Council (PCC) met on Thursday, December 14, and Friday, December 15, 2023. Below is a summary of topics discussed by PCC and FASB members at the meeting:

• Stock Compensation Disclosures (PCC Research Project): FASB staff and members of the PCC’s stock compensation disclosures working group summarized outreach conducted with private company preparers, practitioners, and users. Several PCC members expressed preliminary support for adding a project on stock compensation disclosures to the PCC’s technical agenda, while some PCC members questioned whether this is a pressing and pervasive issue for private companies. PCC members

noted that many users have access to management and detailed information, such as capitalization tables, and may not find certain required stock compensation disclosures decision useful. Some PCC members noted that some stock compensation disclosures may be costly for private companies to prepare, largely driven by whether the entity uses software to generate the required disclosures and by the complexity of the company’s stock compensation plans. PCC members indicated that no additional research was necessary before deciding whether to add a project to the PCC’s technical agenda at a future meeting.

• Accounting for Government Grants: The PCC discussed the Board’s recent decision to add a project to its technical agenda on the accounting for government grants received by business entities and recent Board decisions on scope, recognition, measurement, and presentation. Some PCC members supported the Board’s decision to have a separate, costaccumulation model for grants related to assets, while other PCC members indicated preference for a single model with gross presentation of all grants recognized. Some user PCC members indicated that disclosure of the ongoing impact of grants related to assets, in periods subsequent to grant recognition, could be decision useful.

• Scope Application of Profits Interest Awards: PCC members supported the Board’s decisions made during redeliberations of the amendments in the proposed Update, Compensation— Stock Compensation (Topic 718): Scope Application of Profits Interest Awards, at its November 1, 2023 meeting. PCC members asked for clarification on how the Board determined which additional characteristics to add to the illustrative example in the Codification. PCC members

suggested that educational materials or communications about the final Update could be provided through state CPA societies, PCC liaison meetings, and FASB webcasts.

• Revenue Implementation: FASB staff provided a summary of feedback received at the November 10, 2023, public roundtable on the FASB’s postimplementation review of Topic 606, Revenue from Contracts with Customers. A preparer PCC member who participated in the roundtable provided additional details on the roundtable discussion in the areas of benefits, costs, implementation challenges, and improvements to the standard-setting process. PCC members discussed areas in Topic 606 that could be considered for potential future standard setting for private companies, such as presentation of contract assets and contract liabilities, short-cycle manufacturing, and variable consideration for long-duration contracts.

• Leases Implementation: PCC members discussed recent observations about the implementation of Topic 842, Leases, and feedback received at the Risk Management Association (RMA) liaison meeting, indicating that the RMA members expressed a need for additional information to distinguish related party leases from third-party leases. PCC members also discussed continuing implementation issues, such as the determination of the incremental borrowing rate and the election to use the risk-free discount rate.

• Credit Losses Implementation: PCC members discussed recent observations on the status of private company implementation of Topic 326, Financial Instruments—Credit Losses (CECL). Some PCC members described challenges related to applying certain aspects of CECL, such as developing reasonable

and supportable forecasts on trade receivables and similar types of financial assets held by nonpublic commercial entities. Other PCC members discussed how the implementation of CECL, while not significant to their financial statements, provided an unexpected benefit to their internal management reporting. PCC members also emphasized a need to continue promoting awareness of the guidance among private company stakeholders.

• Accounting for Environmental Credit Programs: FASB staff provided PCC members with an update on the Accounting for Environmental Credit Programs project and a summary of the recent Board decisions on scope and asset recognition and measurement. PCC members noted that while they do not currently have extensive experience with environmental credits within the scope of the project, they support the Board’s consideration of the project as both compliance and voluntary programs are becoming more prevalent. PCC members also asked clarifying questions about the project, including its interaction with the FASB’s Accounting for Government Grants project and consideration of fair value measurement for a subset of environmental credits.

• Induced Conversions of Convertible Debt Instruments: The PCC’s EITF observer member provided an overview of the project and the consensus-forexposure reached by the EITF at its September 14, 2023, meeting and the ratification by the Board at its October 4, 2023, meeting. A proposed Accounting Standards Update was issued on December 19, 2023, with a 90-day comment period.

• Town Hall/Liaison Meeting Update: PCC members and FASB staff discussed feedback received during the following

recent liaison meetings: (1) RMA’s Accounting Working Group, (2) Auditing Standards Board Audit Issues Task Force, and (3) AICPA Private Companies Practice Sections (PCPS) Technical Issues Committee (TIC). FASB staff also noted that the PCC will hold a liaison meeting with the Institute of Management Accountants Small Business Committee in March 2024 and will participate in the AICPA ENGAGE Conference in June 2024.

FASB staff also noted that the FASB held its semiannual webcast, IN FOCUS: FASB Update for Private Companies and Notfor-Profit Organizations, on December 11, 2023.

• Other Business: An FASB member thanked Candy Wright, outgoing PCC Chair, for her significant contributions to the PCC during her eight-year tenure. The PCC Chair thanked outgoing PCC members, Jeremy Dillard and Mike Minnis, for their service to the PCC.

The next PCC meeting is scheduled for Thursday, April 18, and Friday, April 19, 2024.

PCC Meeting Recaps are provided for those interested in following the activities of the PCC. Official positions of the PCC and the FASB are reached only after extensive due process & deliberations. More details on the PCC’s input on the FASB’s projects can be found within the meeting minutes, which will be published on the PCC website in the coming weeks.

THE FOLLOWING ARE SELECTED TOPICS FROM THE WEEKLY ACCOUNTING HIGHLIGHTS PUBLISHED BY THOMSON REUTERS – FULL ATTRIBUTION TO SOYOUNG HO (SEC matters) and DENISE LUGO (FASB, AICPA matters), WHO WRITE THESE SUMMARIES FOR THOMSON REUTERS

What Are the Consequences of Auditors

Subject to Regulatory Enforcement Actions? Apparently Not Much

Soyoung Ho, Senior Editor, Accounting and Compliance Alert – February 12, 2024

Many public company external auditors who were subject of SEC or PCAOB enforcement actions between 2003 and 2019 did not appear to suffer greatly professionally or financially, an academic study found.

Researchers at Temple University and the University of Michigan looked at what happened to the auditors one year after settled orders were issued by the Securities and Exchange Commission (SEC) or the Public Company Accounting Oversight Board (PCAOB), and they observed three intriguing consequences, or lack thereof.

A significant number of those who were involved in professional misconduct remained gainfully employed by their firms—26% of Big Four firms and 43% of non-Big Four firms.

By contrast for context, another research found that 95% of corporate executives named in the SEC’s accounting and auditing enforcement releases (AAERs) who had enforcement actions against them lost their jobs.

Moreover, auditors who had disciplinary actions against them from the PCAOB suffered less consequences than those who were a subject of the SEC’s AAERs.

In SEC cases, 26% from Big Four firms and 38% from non-Big Four firms remained employed at their firms a year after enforcement. In PCAOB cases, it was 28% for Big Four auditors and 47% for non-Big Four auditors.

If auditors left their jobs at one of the Big Four firms, 79% moved to the corporate sector and landed senior or mid-level executive positions at private companies with an accounting or finance focus. This is partly because regulators often bar auditors from practicing public company accounting for a period of time.

By contrast, 77% of auditors who leave their non-Big Four firm jobs tend to join other non-Big Four accounting firms, often as partners.

Of all culpable auditors that remained in public accounting, 80% held partnerships at the time the data were collected.

“Interestingly, we do not find strong evidence that culpable auditors’ departure is linked to the severity of the misconduct, where severity is measured using either the length of the suspension imposed by regulators or whether only the auditor (rather than both the auditor and audit firm) is subject to enforcement,” the study notes. “This finding suggests that for some culpable auditors, firms are willing to overlook misconduct because the benefits that those individuals provide for the firm outweigh the reputation and operational risk-related costs that they impose on the firm.”

In addition, the researchers also looked at real estate holdings of these auditors as a proxy for wealth effects and found that a large majority do not engage in real estate transactions to come up with cash around the time of enforcement actions.

“The punchline is that many auditors don’t lose their jobs, and the ones that do get other jobs quite easily,” said Mihir Mehta, an accounting professor at the University of Michigan, who is the corresponding author of the working paper dated November 2023.

Others who worked on the research are Jagan Krishnan, Meng Li, and Hyun Jong Park of Temple University.

Analyses indicate that “culpable auditors are more likely to depart their employers when (1) the employer is a Big 4 firm, (2) the enforcement is conducted by the SEC, and (3) when a regulatory suspension is imposed on culpable auditors,” the study states. “We also find that departure is less likely when the individual facing enforcement is a partner.”

Research Might Be of Interest to Regulators

Some might find this troubling since auditors play an important gatekeeper role in the capital markets to make sure that a company’s financial statements are

presented fairly and do not contain material misstatements.

“The study is likely to be of interest to the profession and both regulators overseeing auditor misconduct, especially given the recent comments by [PCAOB Chair] Erica Williams about an increased enforcement focus on individual auditors,” Mehta said.

The PCAOB has stepped up its enforcement efforts after Williams became chair in January 2022 and has imposed record fines; thus, the research does not cover the sanctions and fines under her leadership or SEC Chair Gary Genler’s tenure. He became chair of the commission in April 2021, and the agency’s enforcement has also been aggressive overall.

It is important to note that the study’s conclusion does not offer up specific policy recommendations for regulators.

“We tried not to speak to the ‘correct’ penalty because it is such a complex issue. Hopefully, our findings will help regulators and auditors understand what the cumulative penalties are for misconduct, which in turn might help regulators think about the ‘correct’ penalty,” Mehta explained.

Asked by Thomson Reuters about whether a much higher fine would be a better deterrent against auditor misconduct, Mehta concurred.

“I agree with your assessment that if the goal was to deter misconduct, greater fines could be effective—one stream of academic literature makes this very claim,” he said.

Background and Tidbits From Study

They pored through the SEC’s AAERs and PCAOB enforcement orders. And they collected data about the culpable individuals’ employment, relocation, and real estate holdings using LinkedIn, LexisNexis, Facebook, and Google searches.

The research sample was 465 culpable auditors. Of these, 275 were subject to SEC enforcement, and 190 were subject to

PCAOB enforcement.

It found that enforcement actions against audit-related misconduct does not result in fines for most auditors.

“When fines are imposed, the amounts are modest in magnitude,” the report states. “By contrast, most individuals face suspensions that limit their ability to engage with publicly listed firms in an accounting or audit capacity.”

Despite suspensions from regulators, 40% to 73% of the culpable individuals depart from their firms, which is lower than the 95% rate for corporate managers.

“Our findings suggest audit firms view many culpable auditors as contributing value that exceeds the reputational or risk related costs of retaining these individuals,” the paper notes.

Most individuals who leave are younger than 55 and are employed within a year following enforcement. The study looked at one year because researchers believe that “if the person was going to be forced out, it would happen within one year after the sanction was levied,” Mehta explained.

About 90% faced a temporary or permanent suspension to practice before the regulators. But how long they were suspended depended on the regulator: 34% of SEC cases and 56% of PCAOB cases result in suspensions of two years or less. But 20% of SEC cases and 18% of PCAOB cases result in permanent suspensions.

The suspensions are longer when the SEC is responsible for the enforcement.

The SEC imposed financial penalties in about one third—the PCAOB one half—of all enforcement cases. The amount ranged from $10,000 to $50,000. Those with Big Four firms typically paid higher fines.

The financial penalties appeared to be “modest.” The amounts represent about 7% to 8% of a partner’s annual income and 2% of the penalty imposed on an audit firm.

“The cumulative findings for the

suspensions and fines suggest that the most severe consequences for culpable auditors are via restrictions in their ability to provide professional services or obtain accountingrelated employment at a publicly listed company rather than via fines,” the study explains.

Overall, the large majority of departing individuals were employed within one year after the enforcement date—65% of those from Big Four firms and 78% of individuals from smaller firms.

However, “individuals that do not obtain employment are around retirement age on average and primarily appear to retire,” the research found.

Cash Flows Rules Causing Misleading Valuations of Tech Firms? Some Want FASB to Study

Denise Lugo, Editor,

Accounting and Compliance Alert – January 31, 2024

The FASB should add another project to its agenda on the statement of cash flows because current rules cause analysts to overvalue technology companies that aggressively use stock-based compensation to pay employees, some say.

“Just like shell games, investors are investing in something that is not there,” Niall O’Malley, managing director, portfolio manager at Blue Point Investment Management, said on January 12, 2024. “Emerging and high-growth software companies often generate minimal returns on their income statement as they seek to gain market share. Investors rely on their cash flow from operations and free cash flow to value the company,” he said. “Under current FASB accounting rules, investors and analysts are overvaluing companies that aggressively use stock-based compensation, since an ongoing operating expense is being added to operating cash flows and free cash flows.”

In general, the topic generates a lot of

attention because it involves billions of dollars — up to 8 % of total compensation for public companies in the US. Under current US GAAP, stock-based compensation is recorded as a non-cash expense on the income statement. When creating the statement of cash flows, the stock-based compensation gets added back because it is not viewed to be an actual cash outflow.

The method of compensation particularly for software companies and technology companies have migrated over five times since 2006, and so needs to be broken out clearly and not added back because it’s an ongoing expense, according to O’Malley, who authored, Overstated Cash Flows and Ownership Shrinkage: Accounting Treatment of Stock-Based Compensation Needs to Change, in the Baltimore Business Review. “The models on Wall Street are treating the free cash flow as something that compounds and contributes to the terminal value which is creating a situation where the technology stocks are seriously overvalued,” he said.

Others agree, stating that a better accounting approach would be to add back the stock-based compensation in the financing section of the statement, or do an offsetting entry.

“Today stock comp has been accounted for when you calculate diluted shares outstanding but future stock comp is not accounted for. That’s a big number for some of these companies — it’s all of their free cash flows and more,” Cornell University business school professor Sanjeev Bhojraj said on January 16. “For some of them it could reduce the valuation by significant numbers.”

Bhojraj explained that two transactions are effectively happening at the same time: one is that the employee is working for the firm and therefore is getting compensated; the other is that the employee is essentially a provider of capital. “In other words, you’re adding back a non-cash cash and inflating

your future cash flows, while not adequately accounting for the potential increase in future stock issuances,” he said.

FASB has Narrow Project for Financial Institutions

The statement of cash flows is one of several that companies must file with the SEC. Some have stressed that since issuance in 1987, ASC 230, Statement of Cash Flows has not been substantially revised by the FASB although much has changed since then.

The board took note and last year added a project to its technical agenda to revise the standard in a targeted way to focus on enabling financial institutions to do a better job of telling their story about cash interest received. A research project was also kept to consider further improvements to the statement of cash flows but it is not yet clear what path that will take.

“The technical agenda project (Statement of Cash Flows—Targeted Improvements) does not take up the issue of stock comp,” a FASB spokesperson told Thomson Reuters on January 12 via email in response to a query. “However, there is still a research project on the agenda to consider further improvements to the statement of cash flows,” she said. “We are currently assessing all feedback in that project.”

So far the FASB has gotten mixed responses from investors, according to the board’s discussions last year. Two years ago, the board heard that it was an important topic, ranking high on the list among those it should address. But a subsequent survey the board submitted to 9,000 investors in 2023 to gauge the appetite for revisions received lackluster response. Only 44 investors responded to the survey and staff had to do further outreach to get feedback from about two dozen more.

“What should I take from a survey on a topic to an investor that doesn’t respond?”

FASB Chair Richard Jones observed during

the meeting. “Even those who responded said that they ‘get what they need today’ which I thought was an interesting response.”

Accountants Predict Easier Year as Big Ticket FASB Changes Aren’t on the Table

Denise Lugo,

Editor, Accounting and Compliance Alert – January 10, 2024

This year will be easier for reporting companies than prior years because the FASB scaled back somewhat on major standardsetting initiatives, accountants said.

“There aren’t any major standards becoming effective this year comparable to revenue recognition, leases, or credit losses – except perhaps for smaller reporting companies in the insurance industry that need to adopt new guidance for long-dated insurance contracts,” Scott Ehrlich, president of Mind the GAAP, LLC, said on January 9, 2024. “I think this reprieve was by design –the FASB recognized that there have been some major GAAP changes in recent years and have somewhat scaled back on their major standard setting activities.”

For public companies, the biggest change for 2024 will come at the end of the year when they need to disclose more segment information, said Ehrlich. For private companies, “there’s not really much new to worry about in 2024,” he said. “Still, private companies may want to use this opportunity to start preparing for some of the big changes coming in 2025 and beyond, including the accounting for joint venture formations and more granular disclosures around cash taxes paid by jurisdiction.”

Others also flagged insurance rules as ones that will heat up heavily later in the year, observing that the accounting landscape feels similar to last year’s but could change. “2023 and 2024 feels about the same and so you feel like you’ve got a fair comparable,” Jim Cox, CFO of Clearwater Analytics, said on January 8. “From a macro perspective it

comes down to the fed and the budget and then the third thing is the election,” he said. “It feels really early to be talking about an election event but that colors the whole view when you think about 2024.”

Cox’s remarks were in the context of addressing this year’s working environment for businesses and organizations such as the FASB.

Established in 1973, the FASB develops US Generally Accepted Accounting Principles (GAAP) for state and local governments under the governance of the Financial Accounting Foundation, an independent, private-sector, not-for-profit organization trustee body. Four standards that the board published over the past two years take effect on January 1, 2024, including changes to segment disclosures that calendar year-end filers have to adopt:

• Accounting Standards Update (ASU) No. 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures, requires public companies to provide more transparency in both quarterly and annual reports about the expenses they incur from revenue generating business units. Public companies, for example, must disclose any significant expense that is regularly provided to the chief operating decision maker (CODM) and included within each reported measure of segment profit or loss.

• ASU No. 2023-01, Leases (Topic 842): Common Control Arrangements, which provides a practical expedient for private companies and not-for-profit entities that are not conduit bond obligors to use the written terms and conditions of a common control arrangement to determine whether a lease exists and, if so, the classification of and accounting for that lease. The standard also provides new guidance for reporting leasehold improvements associated with common control leases.

• ASU No. 2023-02, Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method (a consensus of the Emerging Issues Task Force), expands the accounting method that was specifically developed for reporting low-income housing tax credit (LIHTC) investments to include more federal and state tax credit investment programs. Specifically, the standard enables other tax credit programs beyond LIHTC investments to qualify for using the proportional amortization method, a simple model that allows the initial cost of the investment to be spread out in proportion to the tax credits and other tax benefits allocated to an investor.

• ASU No. 2022-03, Fair Value Measurement (Topic 820) Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions, which clarifies how to measure equity securities that are subject to a contractual sale restriction.

Narrow Standards Coming in First Quarter

Separately, by the end of March, the FASB plans to issue narrow ASUs on profits interest awards, and to amend the codification to remove conceptual references, according to its technical agenda, published on January 8. The agenda timeline is not set in stone and so issuance dates can change due to technical matters.

The profits interest standard comes from Proposed ASU No. 2023ED300, Compensation—Stock Compensation (Topic 718): Scope Application of Profits Interest Awards, which was issued in May 2023 to provide an example in GAAP. The board subsequently voted last year to finalize the guidance with certain revisions.

Profits interest awards are popular with some companies because they enable

a business to boost compensation for employees and other service providers in a way that aligns with the performance of the business. This in turn gives employees and others an extra incentive toward helping the business to achieve certain operating targets that are tied to profits. But GAAP was lacking in this area and there was some confusion about how to interpret certain guidance.

The standard will introduce an illustrative example and several fact patterns to show how a company should apply the guidance in paragraph 718-10-15-3 to determine whether a profits interest award should be accounted for in accordance with Topic 718, Compensation—Stock Compensation. The example is aimed at reducing complexity and existing confusion about how to report the awards.

The rules will take effect for public companies for fiscal years beginning after December 15, 2024, and interim periods within those fiscal years; and for privately held companies for fiscal years beginning after December 15, 2025, and interim periods within those fiscal years. Early adoption will be permitted.

Removing Concepts from Codification

The other ASU will finalize Section A of Proposed ASU No. 2019-800, Codification Improvements, to remove instances where concepts statements are referenced in the codification.

The changes will take effect for public companies for fiscal periods including interim periods within the fiscal periods beginning after December 15, 2024. For private companies and other entities, the guidance will take effect for fiscal periods including interim periods within those fiscal periods beginning after December 15, 2025. Early adoption will be permitted. (See FASB Votes to Finalize Proposal to Remove

Concepts Statement References from GAAP Codification in the October 5, 2023, edition of Accounting & Compliance Alert.)

The conceptual framework is a nonauthoritative guide the board uses to develop GAAP but the guide is not GAAP.

FASB Votes Against 5

Technical Agenda Requests: Would do More Harm Than Good Denise Lugo, Editor, Accounting and Compliance Alert – December 27, 2023

The FASB on December 20, 2023, voted against adding five new projects to its technical rulemaking agenda, including on accounting for commodities which it will continue to research. The changes would do more harm than good, according to the discussions – the last for the board this year.

The “no” vote on commodities was the biggest surprise because it has been on the board’s research agenda since last year and came with FASB staff recommendations that “there is an identifiable and sufficiently pervasive need to improve GAAP for a subset of entities whose business model is to buy and sell commodity inventory solely for trading.”

But more work needs to be done to reach the rulemaking bar, FASB members said. Further, parallels exist between commodities and a current project on environmental credits which will be addressed in several weeks.

“I think we should progress on the environmental credits project, so I would be supportive of holding this on the research agenda,” FASB Chair Richard Jones said. “Once the board has had a chance to go through environmental credits, my guess there is going to be a decision of ‘yes we want to do something with trading in that project’ or ‘no we want to send it to this project and deal with it broader in commodities,’ or ‘we don’t want to do

anything,’ but at that point bring this back to the board and say ‘okay now with that additional knowledge are you interested in commodities, do you think you have a feasible scope and what would that be,’” he said. “We will bring it back at a time in the future.”

The vote followed a staff analysis that a process that addresses the measurement of commodities inventory held for trading would reduce diversity in practice for some commodities held by financial institutions and move US GAAP closer to IFRS Accounting Standards. Further, staff had recommended that a project be added to the technical agenda with a scope based on the following criteria: the inventory is fungible or interchangeable; the inventory is managed on a fair value basis; the inventory is held for trading purposes.

Overall, the board signaled: caution.

“I’ve said before I think the most important part of the decision before we put something on the technical agenda is getting the scope clear so that we have our elevator speech as to who’s affected and what’s the objective,” FASB member Marsha Hunt said. “And I’m interested because I understand today’s rules don’t present the economic consequences in as meaningful a way as maybe they could,” she said. “But I don’t know that I’m satisfied that we’ve seen a scope yet that I could support.”

Related to the four other topics that didn’t get added, adding projects would introduce problems in GAAP that did not previously exist, according to the discussions.

Specifically, the board voted against projects to:

• clarify the scope of Topic

480, Distinguishing Liabilities from Equity for legal-form debt instruments.

Staff recommend that a project should not be added, flagging that there was

not a solution that did not create other problems.

• reconsider the current accounting for equity securities. Staff recommended that a project should not be added for various reasons, including that proposed solutions would likely increase cost and complexity and may not have an identifiable scope. Further, staff said that the existing disclosure requirements already provide investors with sufficient transparency.

• eliminate the held-to-maturity (HTM) classification for debt securities, or make targeted amendments to any of the following: (a) balance sheet presentation of HTM debt securities (b) fair value disclosure of HTM debt securities by non-public business entities (PBEs) (c) hedge accounting guidance for HTM debt securities. Staff recommended that a project not be added to eliminate HTM classification, including because there is no technically feasible solution “with expected benefits that would justify the expected costs,” and accounting standards were not the cause of the bank failures that the agenda requester flagged.

• A majority of the board also voted against the other HTM issues. However, FASB members favored further research for issues related to interest rate and liquidity risks.to amend Topic 740, Income Taxes, to eliminate the prohibition of backwards tracing, a term for the recognition of current year changes to previously recognized deferred tax amounts in the same line item that they were initially recorded. Staff recommended that a project should not be added, noting that the board has determined in the past that the costs associated with the complexity of tackling the changes outweighed the benefits to users of applying backwards tracing. “The staff does not believe there

is any new information today that has not been previously considered by the board.”

FASB Decision Not to Consider Eliminating Held-to-Maturity for Debt Securities

Disappoints Investor Advocates

Soyoung Ho, Senior Editor, Accounting and Compliance Alert – December 26, 2023

Some investor protection advocates expressed disappointment following the Financial Accounting Standards Board’s (FASB) decision last week not to add a standard-setting project to its technical agenda to consider eliminating held-tomaturity (HTM) classification for debt securities. This accounting approach was highlighted by high-profile bank failures earlier in the year, including Silicon Valley Bank (SVB) in March.

While respecting the board’s decision, Council of Institutional Investors (CII) General Counsel Jeffrey Mahoney said he is “disappointed that the board failed to have any public discussion about the recent empirical evidence by Professor Stephen G. Ryan supporting our proposal to consider eliminating the held-to maturity classification.”

The research showed that banks classify fixed-rate debt investment securities as HTM rather than available for sale (AFS) when HTM classification provides “preferred financial accounting and regulatory capital treatments, not because they have a distinct economically motivated intent and ability to hold the securities to maturity.”

The FASB’s December 20, 2023, decision comes as investor groups, such as the CII and the CFA Institute, urged the accounting board to require companies to account debt securities at fair value on the balance sheet because it provides more useful information to analysts than other accounting methods, including amortized accounting that

accompanies HTM classification for debt securities.

They say that amortized cost measurement does not provide information about key risks such as liquidity, interestrate sensitivity, and asset liability duration mismatches. Amortization might mask the real economics of the underlying financial instruments and the company as a whole.

Not the First Time

This is not a new debate.

In the aftermath of the global financial crisis over a decade ago, there was a debate about whether some financial instruments should be carried at amortized cost or at fair value—AFS.

The FASB had considered but ultimately dropped a 2010 proposal that would have required many financial instruments to be accounted for at fair value.

Investor groups support the fair value option because management intent about what to do with debt securities does not alter the value of a financial instrument, as is allowed under current standard. A mixed measurement model creates inconsistency, making it confusing and difficult to compare between companies. Moreover, the mixed model hides economic mismatches because assets are reported at fair value but liabilities at amortized cost.

Fair value, on the other hand, highlights those mismatches by reporting the changing value of assets and liabilities. The standardsetter retreated from the proposal under political pressure, the CFA Institute noted.

“What that means is that the financial statement carrying value of those financial instruments held -to-maturity is reflected at amortized cost, or what management paid for the asset sometime in the past plus amortization of the discount or premium from the face value. The fair value is only

disclosed on the face of the financial statement and in the footnotes. Any unrealized loss is ‘hidden in plain sight,’” wrote CFA Institute’s Sandra Peters in a blog in March. “But management intent and business model do not change the value of financial instruments. The HTM classification only makes it harder for investors and depositors to see.”

In late April, CII had formally asked the FASB to consider eliminating HTM classification and to improve financial instrument disclosures about liquidity risk and interest rate risk, saying it generally supports the CFA Institute’s recommendation.

SVB had most of its assets invested in fixed income securities and chose to classify $91 billion of those assets as HTM and reported them at amortized cost on the balance sheet with a parenthetical disclosure that those assets had a fair value of $76 billion.

The assets classified as HTM had a $15 billion unrealized loss created largely because of the Federal Reserve’s seven interest rate increases last year, and the loss would have wiped out most of SVB’s total equity of $16 billion at 2022 year-end had it been recognized.

The Fed in February and March again raised interest rates. And SVB suffered a massive run on deposits, leaving the bank with insufficient cash reserves. SVB as a result said that it sold about $21 billion or most of all of its AFS securities at a realized loss of $1.8 billion and sought to raise over $2 billion through stock offerings.

FASB’s Rationale

The FASB staff had recommended that the board not start a project to eliminate the HTM classification because, among other issues, costs would outweigh benefits. And

the information is already in the footnotes.

The board also stated that accounting standards were not the cause of the bank failures, which CII agrees. But the investor group said that the failure raised “legitimate questions” about classifying HTM under Topic 320, Investments–Debt Securities, and the lack of required footnote disclosures about the liquidity risk and interest rate risk of financial instruments under Topic 825, Financial Instruments.

“I am also disappointed the board failed to publicly discuss our proposal, derived from prior recommendations of [former FASB members] Thomas Linsmeier and Marc Siegel, to consider requiring improvements to the footnote disclosures about the liquidity and interest rate risk of financial instruments,” CII’s Mahoney said. “I, however, remain optimistic that a future board will address and resolve the long-standing deficiencies in the financial accounting and reporting of financial instruments.”

On December 20, FASB members said further research is needed for issues related to interest rate and liquidity risks.

Jack Ciesielski, president & portfolio manager of R.G. Associates, Inc. agreed that the FASB’s decision on HTM accounting is “very disappointing.”

“The board skips an opportunity to greatly simplify accounting standards and make financial statements more robust,” said Ciesielski, who also serves as a member of the FASB’s Emerging Issues Task Force and the PCAOB’s Investor Advisory Group.

“By hanging on to HTM accounting, they support a disclosure regime that makes auditors have to assess whether or not an issuer has the ability and wherewithal to actually hold securities to their ultimate maturity – something that some auditors either seem to have forgotten to do last year

or made that assessment carelessly,” he said. “Yet in arguing against adding the project, one board member cited ‘higher costs and complexities for banks.’ That seems to be a misplaced priority – as well as doublespeak.”

Ciesielski’s views are backed by research he has conducted following bank failures, showing that HTM values for debt securities can be very different when compared to market realities.

He looked at what higher interest rates would have done to bank capital if loans and HTM securities were reported at fair value. For example, he looked at 349 banks’ reporting of second quarter of 2023.

The gross carrying value of the loans and HTM securities was $478.3 billion higher than what they would have gotten if they needed to be sold. “In other words, there is $478.3 billion of imaginary assets on the collective balance sheets,” he wrote in his research.

Not Everyone Thinks HTM Accounting is Bad

In the meantime, the FASB’s decision is likely to have support by some accounting experts who believe HTM should not be eliminated.

Denny Beresford, who served as chairman of the FASB from 1987 to 1997, said that the original accounting for marketable securities standard was issued in 1993 in SFAS 115, Accounting for Certain Investments in Debt and Equity Securities.

“I can certainly see excellent arguments both pro and con for the current accounting standards as well as the changes suggested by Peters,” Beresford said in the spring. “But I don’t think long-standing accounting should be changed as a result of one bank failure that could have easily been foreseen had investors, regulators and others read the financial statements with some reasonable care. As Peters’s post said, the matter was ‘hidden in plain sight.’”

Loper Bright Goes Up to Supreme Court and Implications for Federal Agency Regulations

By David Antoni, CPA, Moss Adams; Christopher H. Hanna, JD, LLM, Moss Adams; Eric Krienert, CPA, Moss Adams

An interesting non-tax case on the docket for the US Supreme Court’s current term could have far-reaching implications for the extent of federal agencies’ power in drafting regulations that interpret federal statutes, including US Treasury’s Regulations pursuant to the Internal Revenue Code (IRC).

Recently, the Supreme Court agreed to hear a case questioning the validity of a federal regulation applicable to the fishing industry. Loper Bright Enterprises v. Raimondo, Case No. 22-451, certiorari granted (May 1, 2023)1 . The Supreme Court heard oral arguments in this case on January 17, 2024.

This case is on appeal from the US Court of Appeals for the DC Circuit, Loper Bright Enters. v. Raimondo, 45 F.4th 359, 2022 US App. LEXIS 22463 (DC Cir., Aug. 12, 2022) No. 21-5166.

Forty years ago, in Chevron v. Natural Resources Defense Council, Inc., the Supreme Court ruled that federal courts should defer to a federal agency’s reasonable interpretation of an ambiguous statute that the agency administers even if that court could choose an alternative interpretation.2

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George W. Benson Counsel

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e-mail: gbenson@mwe.com

Guest Writers

David F. Antoni

Tax Managing Director

Moss Adams

Philadelphia, PA tel: (206) 748-4946

mobile: (215) 880-0174

e-mail: dave.antoni@mossadams.com

Christopher H. Hanna, JD, LLM

Moss Adams

tel: 945-221-2442

Moss Adams LLP

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christopher.hanna@mossadams.com

Eric Krienert, CPA, Moss Adams

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eric.krienert@mossadams.com

The Court’s decision in Chevron set forth a two-step analysis for federal courts when considering a legal challenge to an agency’s interpretation of a law. This two-step analysis is many times referred to as the Chevron doctrine:

• First, always, is the question of whether Congress has directly spoken to the precise question at issue. If the intent of Congress is clear, that is the end of the matter; for the court, as

1 The Supreme Court also granted certiorari on October 13, 2023, in Relentless, Inc. v. Department of Commerce, Case No. 221219, raising essentially the same issues as Loper Bright. Oral arguments occurred on January 17, 2024. A decision is expected by the end of the term in June.

2 Chevron v. Natural Resources Defense Council, Inc., 467 US 837 (1984).

well as the agency, must give effect to the unambiguously expressed intent of Congress.

• If, however, the court determines Congress has not directly addressed the precise question at issue, the court does not simply impose its own construction on the statute as would be necessary in the absence of an administrative interpretation. Rather, if the statute is silent or ambiguous with respect to the specific issue, the question for the court is whether the agency’s answer is based on a permissible construction of the statute.3

In a lecture at Duke Law School in 1989, “the late Justice Antonin Scalia characterized Chevron as the most important administrative law decision in the era of the modern administrative state.” 4

This authority of federal agencies has become known as Chevron deference or the Chevron doctrine. In granting certiorari in Loper Bright, the Supreme Court agreed to decide the question presented: “[w]hether the Court should overrule Chevron or at least clarify that the statutory silence concerning controversial powers expressly but narrowly granted elsewhere in the statute does not constitute ambiguity requiring deference to the agency.”5

Why is a case challenging Chevron on a fisheries regulation relevant here?

In Mayo Foundation for Medical Education and Research v. United States (2011), the Supreme Court concluded that “[t]he principles underlying our decision in Chevron apply with full force in the tax context.”6 This decision has allowed Treasury to exercise its authority under Chevron deference in

3 Id. at 842-843.

writing its tax regulations interpreting and implementing its view of Congress’ intent expressed in the statutory language of the IRC.

Issues Before Supreme Court in Loper Bright Enterprises

The petitioners in Loper Bright present a direct challenge to a rule promulgated by the National Marine Fisheries Service (NMFS) under its regulatory authority administering the Magnuson-Stevens Act (MSA). This case could result in a groundbreaking decision if the Supreme Court overturns or significantly limits the scope of Chevron deference.

If the Supreme Court decides in favor of Loper Bright’s petitioners, it opens the door to challenges against a wide range of existing federal regulations as well as placing restraints on federal agencies’ power in future regulatory projects.

Here is the situation presented in the Loper Bright case7 according to the petitioners’ questions section of its petition for certiorari presented to the Supreme Court:

• The MSA governs fishery management in federal waters and provides that the NMFS may require vessels to carry federal observers onboard to enforce the agency’s myriad of regulations. In three narrow circumstances, the MSA goes further and expressly requires operators of vessels to pay the salaries of these federal observers. The statutory question underlying this petition is whether the agency (NMFS) can force domestic vessels to pay the salaries of the monitors they are required to carry, something not expressly provided for in the MSA.

4 See In Loper Bright and Relentless, Supreme Court returns to high-stakes question of viability of the Chevron doctrine, James P. Mcloughlin Jr., Mary Katherine Stukes and Pierce Werner, Reuters (Nov. 7, 2023). Loper Bright’s Counsel of Record on the Petition for Writ of Certiorari who will be arguing this case before the Supreme Court is Paul D. Clement, who served as the 43rd Solicitor General of the US 2005–2008 and interestingly was the late Justice Antonin Scalia’s law clerk 1993–1994.

5 Loper Bright Enterprises v. Raimondo, Case No. 22451, certiorari granted (May 1, 2023). In granting certiorari, the Court has declined to address “[w]hether, under a proper application of Chevron, the MSA implicitly grants NMFS the power to force domestic vessels to pay the salaries of the monitors they must carry.”

6 Mayo Foundation for Medical Education and Research v. United States, 562 US 44, 55 (2011).

7 Loper Bright Enterprises v. Raimondo, Case No. 22451, certiorari granted (May 1, 2023).

• Petitioners argue, under well-established principles of statutory construction, the answer appears to be “no,” as the express grant of such a controversial power in limited circumstances forecloses a broad implied grant that would render the express grant superfluous.

• A divided panel of the DC Circuit Court of Appeals answered “yes” on the theory that statutory silence produced an ambiguity that justified deferring to the agency under the Chevron doctrine.

In granting certiorari, the Supreme Court will decide “whether the Court should overrule Chevron or at least clarify that statutory silence concerning controversial powers expressly but narrowly granted elsewhere in the statute does not constitute an ambiguity requiring deference to the agency.”8

Case Study: Applying Chevron to US Treasury Regulations in Mayo Foundation

In Mayo Foundation, the Supreme Court granted certiorari on June 1, 2010, on appeal by petitioner, from a decision by the US Eighth Circuit Court of Appeals9, which held for the government, reversing the US District Court for the District of Minnesota.10

Mayo Foundation, operating a university hospital medical clinic, filed suit against the United States asserting its doctors serving as medical residents were exempt from Federal Insurance Contribution Act (FICA) taxes under IRC section 3121(b)(10), which in general provides an exemption from FICA taxable employment for services performed in the employment of a school, college, or university, if such service is performed by a student who is enrolled and regularly attending classes at such school, college, or university.

The doctors typically cared for patients, examining and diagnosing them 50–80 hours a week, supervised by senior residents

and faculty members known as attending physicians. The medical residents received an annual stipend, health insurance, malpractice insurance, and paid vacation time. Mayo residents took part in a formal and structured educational program and had written exams. This program provided residents additional education in a specialty to become board certified in that field.

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The doctors typically cared for patients, examining and diagnosing them 50–80 hours a week, supervised by senior residents and faculty members known as attending physicians. The medical residents received an annual stipend, health insurance, malpractice insurance, and paid vacation time.

Treasury Regulation section 31.3121(b)(10)2(d)(3)(iii), promulgated in 200411, provides the services of a full-time employee are not incident to and for the purpose of pursuing a course of study. Pursuant to this regulation, an employee whose normal work schedule is 40 hours or more per week is considered a fulltime employee (“the full-time employee rule”). Therefore, under this regulation, a full-time employee resident’s service is “not incident to and for the purpose of pursuing a course of study,” and accordingly, the resident is not an exempt “student” under IRC section 3121(b) (10).

The District Court held for Mayo, concluding that the regulation’s “full-time employee rule” is inconsistent with the unambiguous text of IRC section 3121(b)(10), which the court

8 Loper Bright Enterprises v. Raimondo, Case No. 22451, petition for writ of certiorari (November 10, 2022)

9 Mayo Foundation for Medical Education and Research v. United States, 568 F.3d 675 (8th Cir. 2009), 2009 US App. LEXIS 12640.

10 Mayo Foundation for Medical Education and Research v. United States, 503 F. Supp. 2d 1164 (D. Minn. 2007), 2007 US Dist. LEXIS 56927.

11 TD 9167, 69 FR 76404 (Dec. 20, 2004).

understood to dictate that “an employee is a ‘student’ so long as the educational aspect of his service predominates over the service aspect of the relationship with his employer.”

The District Court determined the factors governing the Supreme Court’s analysis of regulations12 in National Muffler (1979) “indicate that the full-time employee exception is invalid.”13 The government appealed and the Court of Appeals reversed, applying the Chevron doctrine, concluding “the statute is silent or ambiguous on the question of whether a medical resident working for the school full-time is a ‘student’” for purposes of section 3121(b)(10), and Treasury’s regulation “is a permissible interpretation of the statute.”14

In its opinion, the Supreme Court turned to its two-part Chevron framework, and first asked whether Congress “directly addressed the precise question at issue”. It concluded that Congress did not since the statute did not define the term “student” and did not otherwise attend to the precise question of whether medical residents are subject to FICA. “[N]either the plain text of the statute nor the District Court’s interpretation of the exemption speaks with the precision necessary to say definitely whether the statute applies to medical residents.”

The Court then turned to the second step in the Chevron analysis under which the court “may not disturb an agency rule unless it is ‘arbitrary or capricious in substance, or manifestly contrary to the statute.’”

Mayo asked the Court to apply the multifactor analysis that the Court used to review a tax regulation in National Muffler. In National Muffler, the Court explained:

“In determining whether a particular regulation carries out the congressional mandate in a proper manner, we look to see whether the

regulation harmonizes with the plain language of the statute, its origin, and its purpose. A regulation may have particular force if it is a substantially contemporaneous construction of the statute by those presumed to have been aware of congressional intent. If the regulation dates from a later period, the manner in which it evolved merits inquiry. Other relevant considerations are the length of time the regulation has been in effect, the reliance placed on it, the consistency of the Commissioner’s interpretation, and the degree of scrutiny Congress has devoted to the regulation during subsequent reenactments of the statute.”16

The government countered that the National Muffler standard has been superseded by Chevron. “The sole question for the Court at step two under the Chevron analysis is ‘whether the agency’s answer is based on a permissible construction of the statute.’”17

The Court in reference to National Muffler stated:

“Mayo has not advanced any justification for applying a less deferential standard of review to Treasury Department regulations than we apply to the rules of any other agency. In the absence of such justification, we are not inclined to carve out an approach to administrative review good for tax law only. To the contrary, we have expressly ‘recogniz[ed] the importance of maintaining a uniform approach to judicial review of administrative action.’”18

“The principles underlying our decision in Chevron apply with full force in the tax context. Chevron recognized that ‘the power of an administrative agency to administer a congressionally created … program necessarily requires the formulation of policy and the making of rules to fill any gap left, implicitly or explicitly, by Congress.’”19

12 National Muffler Dealers Ass'n v. United States, 440 US 472 (1979), 99 S. Ct. 1304, 59 L. Ed. 2d 519, 1979 US LEXIS 74.

13 Mayo, 503 F. Supp. 2d, at 1176.

14 Mayo, 568 F. 3d at 679-680, 683.

15 National Muffler, 99 S. Ct 1304, 59 L. Ed. 2d 519.

16 Id. at 477.

17 Mayo, 562 US at 54 citing Chevron, 467 US, at 843.

The Court also noted that in two 1980s decisions predating Chevron, 20 it had written that “’we owe the [Treasury Department’s] interpretation less deference’ when it is contained in a rule adopted under that ‘general authority’ than when it is ‘issued under a specific grant on authority to define a statutory term or prescribe a method of executing a statutory provision.’”21

The former was generally referred to as, interpretative regulations, issued pursuant to IRC section 7805(a), and the latter, was generally referred to as legislative regulations, issued pursuant to a specific code section, such as IRC section 1502 (consolidated return regulations). The Court made it clear, however, that its inquiry “does not turn on whether Congress’s delegation of authority was general [interpretative regulations] or specific [legislative regulations]” noting that “the administrative landscape has changed significantly” since the early 1980s.22

The Court stated:

“Since Rowan and Vogel were decided, however, the administrative landscape has changed significantly. We have held that Chevron deference is appropriate ‘when it appears that Congress delegated authority to the agency generally to make rules carrying the force of law, and that the agency interpretation claiming deference was promulgated in the exercise of that authority.’”23

In deciding Mayo Foundation, the Court declined to apply National Muffler believing

Chevron “provide[s] the appropriate framework for evaluating the full-time employee rule.”24 The Court wrote:

“The Department issued the full-time employee rule pursuant to the explicit authorization to ‘prescribe all needful rules and regulations for the enforcement’ of the Internal Revenue Code [IRC section 7805(a)].

We have found such ‘express congressional authorizations to engage in the process of rulemaking’ to be ‘a very good indicator of delegation meriting Chevron treatment.’25 The Department issued the full-time employee rule only after notice-and comment procedures,26 again a consideration identified in our precedents as a ‘significant’ sign that a rule merits Chevron deference.”27

The Court stated: “This case [Mayo] falls squarely within the bounds of, and is properly analyzed under Chevron and Mead.” 28

The Court further stated: “The full-time employee rule easily satisfies the second step of Chevron, which asks whether the Department’s rule is a ‘reasonable interpretation’ of the enacted text.”29

The Supreme Court applying Chevron concluded in Mayo Foundation, “We do not doubt that Mayo’s residents are engaged in a valuable educational pursuit or that they are students of their craft. The question whether they are ‘students’ for purposes of § 3121, however, is a different matter. Because it is one to which Congress has not directly spoken, and because the Treasury Department’s rule is a reasonable construction

18 Id. at 55 citing Dickinson v. Zurko, 527 US 150, 119 S. Ct. 1816, 144 L. Ed. 2d 143, (1999).

19 Id. at 55-56 citing Chevron, 467 US, at 843.

20 Rowan Cos. v. United States, 452 US 247 (1981);

21 Mayo, 562 US at 56 citing Rowan, 452 U.S. at 253. 455 US 16 (1982).

22 Id. at 56-57.

23 Id. at 57, citing United States v. Mead Corp., 533 US 218 (June 18, 2001) at 226-227, 121 S. Ct. 2164, 150 L. Ed. 2d 292.

24 Id. at 57-58.

25 Id. at 58, citing Mead, supra, at 229.

26 Id. at 57-58, citing TD 9167, supra, 69 FR 76404 (December 21, 2004) promulgating final regulations under IRC 3121(b)(10).

27 Id. at 57-58, citing Mead, supra, at 230-231.

28 Id. at 58.

29 Id. at 58, citing Chevron, 467 U.S, at 844.

30 Id. at 60.

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of what Congress has said, the judgment of the Court of Appeals must be affirmed.”30

Summary

Reflecting on the decision in Mayo Foundation, it seems in applying Chevron, the Court is saying the plain language Congress used in drafting the statute doesn’t necessarily validate the taxpayers’ reliance solely on the statutory language. For example, a medical resident who considers himself or herself as predominantly a student, engaged in a medical program to obtain a specialty certification, may not rely solely on Congress’ statutory language, but also must consider Treasury’s administrative pronouncements. Did Congress’ silence about the definition of the term student intend to allow the Department of Treasury to prescribe Treas. Reg. Section 31.3121(b) (10)-2(d)(3)(iii) without its express consent?

In Loper Bright, NMFS created a rule without Congress’ expressed statutory language. In deciding Loper Bright, will the Court overturn Chevron—or at least clarify that the statutory silence concerning controversial powers expressly but narrowly granted elsewhere in the statute does not constitute ambiguity requiring deference to the agency? Can taxpayers rely on the statute’s wording or is statutory silence to be considered ambiguity?

Any change in the current Chevron deference application to a federal agency’s regulations in Loper Bright by the Supreme Court would appear to apply to US Treasury Regulations as decided in Mayo Foundation. As a result, the outcome of Loper Bright may have implications for taxpayers considering a challenge to the validity of a Treasury

Regulation’s interpretation of a statute of the IRC31. How impactful this case will be in affecting the extent of power federal agencies have in writing regulations remains to be seen.

David Antoni has worked in professional tax accounting since 1986 serving domestic and multinational companies. Dave’s areas of industry focus include life science, food and beverage, cooperatives, consumer and industrial markets, retail, technology, and insurance.

Christopher Hanna is the Alan D. Feld Endowed Professor of Law and the Altshuler Distinguished Teaching Professor at Southern Methodist University. From June 2000 until April 2001, he assisted the U.S. Joint Committee on Taxation in its complexity study of the U.S. tax system. From May 2011 until December 2018, he served as Senior Policy Advisor for Tax Reform to the U.S. Senate Committee on Finance.

Eric Krienert has worked in public accounting and the private industry since 1997. He provides tax compliance, consulting, and planning services to entities in the food and agriculture industries, including familyowned businesses, closely held entities, cooperatives, and venture capital–owned businesses. Eric also provides federal and state income tax planning services to companies with complex M&A activity.

Assurance, tax, and consulting offered through Moss Adams LLP. ISO/IEC 27001 services offered through Moss Adams Certifications LLC. Investment advisory offered through Moss Adams Wealth Advisors LLC.

31 In particular for cooperatives qualifying as Specified Agricultural or Horticultural Cooperatives pursuant to IRC section 199A(g)(4), a favorable ruling to the petitioners by the Supreme Court in Loper Bright may provide some impetus for Treasury to revisit its final IRC section 199A(g) regulations published on January 19, 2021. These regulations provide rules for the Domestic Production Activities Deduction (DPAD) applicable to Specified Agricultural or Horticultural Cooperatives and their Patrons. The final regulations generally provide a non-exempt cooperative (a cooperative other than an IRC section 521 Farmers’ Cooperative) must determine DPAD solely attributable to its patronage sourced elements of DPAD (i.e., Qualified Production Activities Income (QPAI), Domestic Production Gross Receipts (DPGR), Taxable Income and DPGR related W-2 wage limitation), (a so-called patronage-only DPAD rule). The statutory language of IRC section 199A(g) places no such restriction on the computation of DPAD. Cooperatives will be watching the outcome of Loper Bright for any glimmer of hope for a revisit with Treasury.

Conversion of a pre-Subchapter T cooperative into a for-profit corporation

By George W. Benson

Earlier this year, the IRS released a ruling addressing an issue arising from the conversion of a cooperative into a for-profit corporation. Ltr. 202330006 (April 24, 2023).

Background

The cooperative was organized under state law on a nonstock, membership basis. It likely provided its members with either telephone service or electricity. Members had membership interests which gave them the right to share in the cooperative’s earnings on a patronage basis, to control the cooperative and to share in any residual assets upon liquidation. The cooperative allocated its income in the form of capital credits redeemable only at the discretion of the cooperative “as to method, priority, and order of retirement.”

Members who ceased to patronize the cooperative forfeited their membership rights but remained entitled to receive the amounts represented by their capital credits.

The ruling stated that cooperative “does not currently qualify as a tax-exempt organization under section 501(c)(12)” which implies that it did so at one time. Presumably (though the ruling does not so state) the cooperative was either a rural telephone or electric association excluded from Subchapter T by Section 1381(a)(2)(C) and therefore taxed under preSubchapter T law. See, Rev. Rul. 83-135, 19831 C.B. 149.

Under pre-Subchapter T tax law, a cooperative is entitled to exclude the face amount of capital credits distributed to members as a patronage dividend. Members are not required to include the credits in income when received (provided the credits are “payable only in the discretion of the cooperative association”). Treas. Reg. § 1.615(b)(1)(iii). Members are later taxed when the capital credits are redeemed or otherwise disposed of. Treas. Reg. § 1.61-5(b)(2) provides:

“[If such an allocation] is redeemed in full or in part or is otherwise disposed of, there shall be included in the computation of the gross income of the patron, as ordinary income, in the year of redemption or other disposition, the excess of the amount realized on the redemption or other disposition over the amount previously included in the computation of gross income…”

Note, however, if a pre-Subchapter T cooperative pays patronage dividends in the form of stock, members are taxed on “the amount of the fair market value, if any, of such capital stock at the time of its receipt…” Treas. Reg. § 1.61-5(b)(1)(iv).

Proposed plan of conversion

The cooperative proposed to convert into a for-profit corporation in a several step process, resulting in the formation of a holding company (“Newco”) with the current business being conducted by a newly formed, wholly owned limited liability company taxed as a corporation (“Newco LLC”).

The cooperative represented that the conversion would qualify as a Section 368(a) (1)(F) reorganization (“a mere change in identity, form, or place of organization of one corporation, however effected”). Such reorganizations are referred to as “F reorganizations.”

Pursuant to the plan of conversion:

• Capital credits of inactive members will be redeemed for cash.

• Active members “will exchange their interests in [the cooperative] for stock in Newco in proportion to the balance of their capital account balances.” For this purpose, active members’ interests in the cooperative were viewed as consisting of a membership interest and a capital credit account (i.e., their capital credits). Thus, part of the Newco stock received by each active member will be exchanged for the member’s capital credits with the remainder exchanged for the member’s interest in the cooperative.

What the IRS ruled

The tax treatment of inactive members was straight forward. The IRS ruled that inactive members will be taxed on the cash received under Treas. Reg. § 1.61-5(b)(2). Since inactive members forfeited their membership interests when they became inactive, they will receive nothing else in the conversion.

The tax treatment of active members is not so straight forward.

Generally, capital credits in a cooperative are viewed as representing an equity interest, not a debt interest, in the cooperative. In an F reorganization, the tax treatment of stockholders is governed by Section 354(a)(1), which provides, subject to a few exceptions listed in Section 354(a)(2), that “[n]o gain or loss shall be recognized if stock or securities in a corporation … are exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.”

Seemingly (since none of the listed exceptions applies), active members should not have been taxed on the conversion since all they received in the conversion was stock in Newco (and that stock was not “nonqualified preferred stock” within the meaning of Section 351(g)). However, that is not what the ruling concluded. The ruling holds that the exchange of capital credits for Newco stock will be “treated as a redemption or other disposition of the capital credits” as described in Treas. Reg. § 1.61-5(b)(2) quoted above.

Query, was this the holding the cooperative requested? The ruling does not say. It may be that the cooperative did not care if most members used its services for personal rather than business purposes. Treas. Reg. § 1.615(b)(3)(i) provides:

“Amounts which are allocated on a patronage basis by [the cooperative] with respect to supplies, equipment, or services, the cost of which was not deductible by the patron under section 162 or section 212, are not includible in the computation of the gross income of such patron.”

However, this would not cover Newco stock received by active members that used the

services of the cooperative in a business and deducted the cost of the services.

The ruling does go on to rule that the exchange of active members of the membership interests in the cooperative for stock in Newco will be tax free.

“(1) the exchange of active members’ interests in Taxpayer for Newco stock will qualify as an exchange under section 354(a) provided the Potential Reorganization otherwise qualifies as a reorganization under section 368(a)(1)(F).”

Implications

The ruling does not describe why it concluded that Section 354(a) did not apply to the exchange of capital credits for Newco stock. Presumably, the IRS concluded that Treas. Reg. § 1.61-5(b)(2) trumped Section 354(a) and that it was appropriate to tax members on their receipt of Newco stock. Maybe it felt justified in reaching that conclusion because of stock rather than capital credits had originally been used by the cooperative, members would have been taxed up front. Or, it may have concluded that this was a proper result when an entity ceases to be a cooperative.

Does this ruling have any implications for Subchapter T cooperatives? Since most capital credits issued by Subchapter T cooperatives are “qualified” and included in income by members at their stated dollar amount upon receipt, a later redemption or other disposition of the capital credits usually does not give rise to tax.

“Nonqualified” written notices of allocation are another story.

If, in a similar conversion involving a Subchapter T cooperative, nonqualified written notices are exchanged for stock, would be exchange be taxable? The answer is not clear.

The rules applicable to nonqualified notices of a Subchapter T cooperative are different from those applicable to capital credits of a pre-Subchapter T cooperative. For instance, a pre-Subchapter T cooperative is allowed a deduction when it issues capital credits. A Subchapter T cooperative is not allowed a deduction when it issues “nonqualified”

written notices of allocation but is allowed a deduction (or a look-back benefit) “for money or other property (except written notices of allocation) in redemption” of the notices. Section 1382(b)(2). Generally, capital stock is regarded as a written notice of allocation at least when issued by a cooperative. But is it a written notice of allocation if it represents an interest in a for-profit corporation? That question has not ever been addressed.

Keeping the cooperative deduction and the patron income inclusion in synch for nonqualified written notices seems appropriate. If the cooperative is not allowed a deduction, perhaps members should not have income. But note that when the holder of a nonqualified notice sells the notice to a third party for cash, the cooperative does not get a deduction so keeping things in synch may be important, but not controlling.

These differences need to be factored into any analysis and could very well lead to a different conclusion.

Tax protestor penalized, among other things, for failure to report patronage dividends

By George W. Benson

The tax treatment of patronage dividends played a small role in a recent Tax Court case involving a person the Tax Court characterized as a “tax protestor.” See, Lawrence James Saccato v. Commissioner, T.C. Memo. 202396 (July 25, 2023). The case ploughed no new ground and is discussed here simply for completeness.

Mr. Saccato was, in the Tax Court’s words, a “serial nonfiler” who had “failed to file Federal income tax returns for an uninterrupted period of at least 14 years,” including the four years before the Tax Court. The IRS asserted, and the Tax Court concluded, that he owed tax on unreported income for each of those years, plus penalties for failure to file, failure to pay and failure to pay estimated tax.

The income Mr. Saccato failed to report included minor amounts of patronage dividends. This income was, of course, held to be taxable to him.

“The IRS determined in the notice of deficiency that for 2013-2016 petitioner received but did not report patronage dividends of $56, $11, $16, and $16, respectively. These amounts appear on Forms 1099-PATR, Taxable Distributions Received from Cooperatives, issued to petitioner by the Douglas County Farmer’s Co-op.

‘Patronage dividends’ are includable in gross income unless an exception applies. § 1385(a); Ag Processing, Inc. v. Commissioner, 153 T.C. 34, 46 (2019). Petitioner conceded at trial that he received these amounts but offered frivolous arguments in contending that they are excludable from his gross income. We hold that the patronage dividends are taxable to him as determined in the notice of deficiency.”

The “frivolous arguments” for not including patronage dividends in income were apparently not related to their status as patronage dividends, but rather typical tax protester arguments. The Tax Court’s discussion of the failure to include patronage dividends is limited to the two paragraphs listed above. There were a number of other items the taxpayer did not include, all of which were more substantial.

The Tax Court imposed a penalty on Mr. Saccato of $10,000 under Section 6673(a) (1). Section 6673(a) authorizes the imposition of penalties in a Tax Court proceeding not in excess of $25,000 when it is determined that “the taxpayer’s position in such proceeding is frivolous or groundless” or the proceedings “have been instituted or maintained by the taxpayer primarily for delay.”

The Tax Court concluded that both grounds were applicable, noting that Mr. Saccato argued, among other things “that he is exempt from Federal income tax because he is ‘a citizen of the State of Oregon’ and ‘not a federal citizen’” and that “the notice of deficiency was invalid because ‘it was not signed under penalties of perjury by a duly authorized assessment officer,’” neither of which, the Tax Court noted, is required. In addition, he argued that “he ‘never elected to be treated as a taxpayer’ [and] that he

‘was protected through the doctrine of estoppel…’”

The Tax Court concluded:

“Although petitioner maintains that ‘[he] is not a tax protestor,’ his filings in this Court belie that contention. His persistent filing of frivolous papers has wasted the Government’s time and ours. We will accordingly require that he pay to the United States a penalty of $10,000.”

The Washington State Review and Hearings Division finds the wholesale B&O tax applicable to a purchasing cooperative

By George W. Benson

A March 7, 2019 determination of the Administrative Review and Hearings Division of the Washington Department of Revenue was recently posted as DOC 2023-37151 (December 27, 2023) in Tax Notes Today. The official citation is Det. No. 19-0072, 42 WTD 058 (2023). There is no explanation why release was delayed for four years.

This determination involves an unidentified out-of-state group purchasing cooperative with members in Washington. The cooperative had not been paying tax in Washington, and its activities came to the Department of Taxation’s attention in early 2017. An audit commenced of the cooperative’s 2010 to 2017 years. The auditor concluded that the cooperative was subject to the wholesale Business and Occupation (“B&O”) tax on sales to Washington members.

The cooperative appealed to the Administrative Review and Hearing Division. The Hearings Division affirmed the audit assessment and denied the cooperative’s petition.

The cooperative’s sales to Washington members took two forms, “reload sales” and “agency sales.”

• Reload sales involved sales of merchandise which the cooperative purchased in its own name and which the cooperative had shipped to it at a public warehouse. The

merchandise was temporarily stored there and then sold to members. A member could either pick up the merchandise at the warehouse or have it shipped by the cooperative to the member’s place of business.

• Agency sales involved sales of merchandise which the cooperative purchased but had drop shipped directly from vendors to members. According to the determination, “[the cooperative receives an invoice for payment from the vendor, pays the vendor, and then bills the member for the purchase price plus [a] commission or fee.”

In the appeal, the cooperative conceded that it was liable for B&O tax on reload sales. However, it disagreed with the determination that it was liable for wholesale B&O tax on the full proceeds from agency sales, contending that it was liable for tax only on the commissions and fees received with respect to such sales, a much smaller amount.

The cooperative made two arguments, both of which were rejected.

First, the cooperative argued that it was not subject to wholesale B&O tax on agency sales under Rule 159. The Hearings Division stated that under that rule “the gross income of agents that make retail or wholesale sales [or purchases] in the name of the actual owner, or principal, is considered the amount derived from making such sales [or purchases], which is generally a commission.” (brackets in original). However, the rule applies “only when the contract or agreement between such persons clearly established the relationship of principal and agent” and certain other conditions are met.

The Hearings Division concluded that the contract or agreement requirement was not met:

“In discussions with Compliance during examination, and in its pre-hearing supplemental memorandum, Taxpayer conceded that no written agreement exists between taxpayer and its members regarding the relationship of the parties in sales and

purchase activity. [Taxpayer also failed to provide any other evidence that clearly established the relationship of principal and agent.]” (brackets in original).

Because of the absence of a written agreement, the Hearings Division did not feel it necessary to go further and engage in a detailed factual review to determine whether an agency relationship existed.

Second, the cooperative argued that a Rule 202, applicable to “pool purchases,” applied. Where two or more persons jointly purchase merchandise “for the purpose of obtaining a purchase price or freight rate which is less than when purchased or delivered in smaller quantities” and one of the persons takes the lead as the named customer of the vendor, then, assuming various conditions are met, the person who takes the lead is subject to B&O tax only on the portion of the purchase that it retains for use in its business.

While the “pool purchase” rule might apply to some rudimentary cooperative arrangements (for instance, where there is no cooperative entity as such), the Hearings Division concluded that it did not apply to the cooperative, pointing to condition 3 of Rule 202.

That condition provides:

“The pool purchase agreement provides that each member shall accept a specific portion of the shipment.”

The Hearings Division cited an earlier determination involving a cooperative formed to acquire automotive parts and supplies for its members. See, Det. No. 92-237R, 13 WTD 126 (1993). Some of the goods were direct shipped to members, some went to the cooperative’s warehouse but were segregated for the member that ordered them, and others went into an inventory that the cooperative maintained to meet member needs. For direct ship sales and those that passed through its warehouse but were segregated, the vendors billed the cooperative and the cooperative then billed members at cost plus a 4% markup. For parts that entered the cooperative’s inventory and then were resold to members,

the cooperative billed members at cost plus a 6% mark-up.

The automotive parts cooperative argued that “imposition of the tax under these facts would be commercially unreasonable.” The Hearings Division was not sympathetic:

“The taxpayer has been formed as a separate entity to fulfil what is essentially a wholesaling function. The taxation of this entity is not unreasonable per se. It is not the Department’s responsibility to exempt the taxpayer from taxation in order to make it more competitive with larger businesses that can buy at bulk rates in their own right.”

In the recent determination, the Hearings Division found the prior determination dispositive:

“We identified ‘a basic problem with the taxpayer’s arguments because Rule 202 contemplates that a pool purchase will be made by two or more persons doing substantially the same type of business; i.e., two or more retailers. … [The] members made retail sales to the public, but the principal member does not.’ …

For Taxpayer’s agency sales here, the requirements of the rule have not been met. The taxpayer was not participating in a joint purchase. Rather it bought all goods for resale to the putative pool members. As we have previously held, the plain language of Condition number 3 in Rule 202 contemplates that the principal member retains some of the commodities for its own inventory. …

As we did in 13 WTD 126, we hold that Rule 202 was not intended to allow taxpayers to avoid wholesaling B&O tax… Taxpayer has been formed as a separate entity to fulfill what is essentially a wholesaling function. Its business activities are more like that of a wholesaler in that it acquires goods from suppliers on behalf of, and for resale to, retailer members, even though the taxpayer’s cooperative structure is probably not representative of most wholesale-retail relationship. Accordingly, we find Taxpayer was not a pool purchaser and is thus ineligible for the Rule 202 deduction.”

First and foremost, TCA wishes to thank NCFC for allowing us to re-publish selected FASB Update sections from the report.

ASU’s falling under ASC Topic 326 Update

2016-13 —Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments

This update was subsequently updated ASU 2018-19, 2019-15, 2019-11, 2020-03, 202202

Effective Date: Public entities that are U.S. Securities and Exchange Commission filers, this update is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. For all other entities, as amended by ASU 2019-10, fiscal years beginning after December 15, 2022, including interim periods within those fiscal years.

Cooperative Impact Assessment: ASC Topic 326 is expected to have moderate impact on farmer cooperatives. The most significant impact will be to those cooperatives carrying Available-for-sale debt securities, trade receivables, and/ or, those that offer financing programs to

EDITOR

Barbara A. Wech, Ph.D.

Department of Management, Information Systems, and Quantitative Methods

University of Alabama at Birmingham

COLLAT School of Business

710 13th St. South

Department of Management, Information Systems, & Quantitative Methods

Birmingham, Alabama 35233 bawech@uab.edu

GUEST WRITER

2023 NCFC Legal, Tax and Accounting Subcommittee Reports FASB Update – Selected Sections

their members. Guidance is to move from an “incurred loss” standard to a “current expected” loss standard. This guidance impacts the evaluation of allowance for credit losses, allowing cooperatives to utilize forward looking information in the calculation. There will be more of an impact on cooperatives carrying long-term receivables vs short-term receivables.

Assets Measured at Amortized costThe amendments in this Update are an improvement because they eliminate the probable initial recognition threshold in current GAAP and, instead, reflect an entity’s current estimate of all expected credit losses. Previously, when credit losses were measured under GAAP, an entity generally only considered past events and current conditions in measuring the incurred loss. Inputs used to record the allowance for credit losses generally will need to change to appropriately reflect an estimate of all expected credit losses and the use of reasonable and supportable forecasts.

Available-for-Sale Debt Securities - The

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amendments in this Update require that credit losses be presented as an allowance rather than as a writedown. This approach is an improvement to current GAAP because an entity will be able to record reversals of credit losses (in situations in which the estimate of credit losses declines) in current period net income, which in turn should align the income statement recognition of credit losses with the reporting period in which changes occur. Current GAAP prohibits reflecting those improvements in current period earnings.

ASU 2018-19 clarifies that receivables arising from operating leases are not within the scope of Subtopic 326- 20. Instead, impairment of receivables arising from operating leases should be accounted for in accordance with Topic 842, Leases.

Update 2019-10 —Financial Instruments –Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842)

Effective Date: Fiscal years beginning after December 15, 2022, including interim periods within those fiscal years

Cooperative Impact Assessment: Under this update, a major Update would first be effective for bucket-one entities, that is, public business entities that are Securities and Exchange Commission (SEC) filers, excluding entities eligible to be smaller reporting companies (SRCs) under the SEC’s definition. The Master Glossary of the Codification defines public business entities and SEC filers. All other entities, including entities eligible to be SRCs, all other public business entities, and all nonpublic business entities (private companies, not-for-profit organizations, and employee benefit plans) would compose bucket two. For those entities, it is anticipated that the Board will consider requiring an effective date staggered at least two years after bucket one for major Updates. Generally, it is expected that early application would continue to be allowed for all entities. The standard clarified

the effective date for Topic’s 326, 815 and 842.

Update 2021-01 —Reference Rate Reform (Topic 848): Scope

Effective Date: Upon issuance (January 7, 2021) through December 31, 2024, as amended by ASU 2022-06.

Cooperative Impact Assessment: Specifically, certain provisions in Topic 848, if elected by an entity, apply to derivative instruments that use an interest rate for margining, discounting, or contract price alignment that is modified as a result of reference rate reform. Amendments in this Update to the expedients and exceptions in Topic 848 capture the incremental consequences of the scope clarification and tailor the existing guidance to derivative instruments affected by the discounting transition. ASU 2022-06 defers the sunset date of Topic 848 from December 31, 2022, to December 31, 2024, after which entities will no longer be permitted to apply the relief in Topic 848.

Update 2021-08 —Business Combinations (Topic 805)

Effective Date: For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years.

Cooperative Impact Assessment: This update will have moderate impact to cooperatives in business combinations that include contract assets and liabilities. The amendments in this Update require that an entity (acquirer) recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606. At the acquisition date, an acquirer should account for the related revenue contracts in accordance with

Table of Topic 606 as if it had originated the contracts. To achieve this, an acquirer may assess how the acquiree applied Topic 606 to determine what to record for the acquired revenue contracts. Generally, this should result in an acquirer recognizing and measuring the acquired contract assets and contract liabilities consistent with how they were recognized and measured in the acquiree’s financial statements (if the acquiree prepared financial statements in accordance with generally accepted accounting principles [GAAP]). However, there may be circumstances in which the acquirer is unable to assess or rely on how the acquiree applied Topic 606, such as if the acquiree does not follow GAAP, if there were errors identified in the acquiree’s accounting, or if there were changes identified to conform with the acquirer’s accounting policies. In those circumstances, the acquirer should consider the terms of the acquired contracts, such as timing of payment, identify each performance obligation in the contracts, and allocate the total transaction price to each identified performance obligation on a relative standalone selling price basis as of contract inception (that is, the date the acquiree entered into the contracts) or contract modification to determine what should be recorded at the acquisition date.

The amendments in this Update also provide certain practical expedients for acquirers when recognizing and measuring acquired contract assets and contract liabilities from revenue contracts in a business combination.

Under current GAAP, an acquirer generally recognizes assets acquired and liabilities assumed in a business combination, including contract assets and contract liabilities arising from revenue contracts with customers and other similar contracts that are accounted for in accordance with Topic 606, at fair value on the acquisition date. The amendments in this Update require acquiring entities to apply Topic 606 to recognize and measure contract assets and contract liabilities in a business combination.

Update 2022-04 —Liabilities – Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations

Effective Date: Fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, except for the amendment on roll forward information, which is effective for fiscal years beginning after December 15, 2023

Cooperative Impact Assessment: This update will be applicable to cooperatives utilizing supplier finance programs, which also may be referred to as reverse factoring, payables finance, or structured payables arrangements, allow a buyer to offer its suppliers the option for access to payment in advance of an invoice due date, which is paid by a third-party finance provider or intermediary on the basis of invoices that the buyer has confirmed as valid. The amendments in this Update require that a buyer in a supplier finance program disclose sufficient information about the program to allow a user of financial statements to understand the program’s nature, activity during the period, changes from period to period, and potential magnitude. To achieve that objective, the buyer should disclose qualitative and quantitative information about its supplier finance programs.

Update 2023-01 — Leases (Topic 842): Common Control Arrangements

Effective Date: Effective fiscal years beginning after December 15, 2023, and interim periods within those fiscal years

Cooperative Impact Assessment: This will have an impact on cooperatives that have leases with joint venture entities. Overall it is meant to ease the burden on the application of the lease standard when common control exists. The first issue address terms and conditions to be considered and offers a practical expedient for private companies and not-for-profit entities that are not conduit

bond obligors to use the written terms and conditions of a common control arrangement to determine:

1. Whether a lease exists and, if so,

2. The classification of and accounting for that lease.

The practical expedient may be applied on an arrangement-by-arrangement basis. If no written terms and conditions exist (including in situations in which an entity does not document existing unwritten terms and conditions in writing upon transition to the practical expedient), an entity is prohibited from applying the practical expedient and must evaluate the enforceable terms and conditions to apply.

The second issue addresses accounting for leasehold improvements. The amendments in this Update require that leasehold improvements associated with common control leases be:

1. Amortized by the lessee over the useful life of the leasehold improvements to the common control group (regardless of the lease term) as long as the lessee controls the use of the underlying asset (the leased asset) through a lease. However, if the lessor obtained the right to control the use of the underlying asset through a lease with another entity not within the same common control group, the amortization period may not exceed the amortization period of the common control group.

2. Accounted for as a transfer between entities under common control through an adjustment to equity (or net assets for not-for-profit entities) if, and when, the lessee no longer controls the use of the underlying asset.

ESG Update

Our prior year report introduced the importance that environmental, social, and governance (“ESG”) initiatives are having within cooperatives. An increasing number of contingents believe that good corporate

citizenship and responsible business practices are just as important as profitability – this is true regardless of industry or sector. An increasing number of stakeholders, including employees, customers, suppliers, governments, and the general public are aware of this interconnectedness and are using ESG factors to assess an organization’s performance, societal and environmental impact and quality of governance.

This update provides a high-level overview of various ESG areas to evaluate as companies consider embarking on their own ESG journeys, as well as examples of what CoBank is doing in each of these areas. Additional details on CoBank’s ESG activities can be obtained from its 2022 Sustainability Report at www.cobank.com.

Materiality Assessment

An ESG materiality assessment is a process that evaluates the impact that ESG topics can have on an organization as well as the impact that an organization can have on the economy, environment and people. ESG materiality - as a concept - is different from financial statement materiality and typically focuses on perceived impact.

There are hundreds of ESG topics that are considered part of the overall ESG “universe.” A materiality assessment helps organizations identify ESG topics that are relevant and perceived to be impactful by internal and external stakeholders. Stakeholder feedback regarding perceived impact allows leadership to consider and focus attention and effort on ESG topics that are most impactful from operational, financial, reputational, strategic, and regulatory perspectives.

A materiality assessment is just one input when identifying ESG priorities for an organization. Other factors or individual organization considerations may impact what ultimately an organization’s leadership decides to pursue or prioritize.

Example: CoBank conducted a formal

ESG materiality assessment in the Fall of 2022 guided by Farm Credit’s mission to support rural communities and agriculture with reliable, consistent credit and financial services. The results of this assessment led us to evaluating the impact of 33 material ESG topics of which 7 were identified as priority topics and were the focus of our efforts and reporting.

ESG Strategy

ESG encompasses an extensive range of risks, opportunities and potential disruptors. If an organization chooses to do so, defining an ESG ambition and strategy can integrate purpose into an overarching business strategy and help minimize siloed business initiatives.

The building blocks of an ESG strategy include an overall ambition the organization will drive towards, supported by thematic strategy pillars and focus areas. Based on the scale of the organization, level of detail in an ESG strategy will vary – a simple ESG strategy may be sufficient for smaller or less complex organizations while larger or more complex organizations may prefer a more detailed and comprehensive ESG strategy. An ESG strategy explicitly incorporates sustainability and social responsibility into the strategic decision-making process of an organization to align business objectives with stakeholder values and expectations by considering ESG risks and opportunities, thereby creating long-term value.

Example: CoBank’s ESG strategy includes an ambition statement and three strategic themes: Customers & Products, Ecosystem Engagement, and Internal Operations.

ESG Governance

A well-designed ESG governance structure helps align ESG activities with institutional values and priorities and helps protect against reputational and financial risks. It also identifies opportunities for improved stakeholder relations, enhances brand and reputation and increases access to new

markets or investment sources.

Governance is a set of rules and practices that spans the organization, often defined by regulatory involvement and requirements and executed by the Board of Directors. The underlying infrastructure is an aggregation of governance operating models – the people, processes, technologies and activities put in place to govern an organization’s operations; as well as the processes used to inform and report out to the Board. ESG in this context is a framework that helps stakeholders understand how an organization will approach managing risks and opportunities relating to environmental, social, and governance criteria, which encompasses a broad range of issues, some of which are interrelated and many of which are evolving. The “G” in ESG encompasses both traditional governance topics, as well as the governance systems in place to manage environmental and social risks and opportunities.

The Board’s Role

The Board of Directors plays a key role in setting the ESG agenda for a company. While some companies may create a standalone Board committee specifically to oversee ESG matters, others may opt not to do so. In the absence of a dedicated Board committee, ESG responsibilities may be spread across various roles of the Board. There is no one-size-fits-all approach to assigning oversight of ESG issues to Boards and committees. Companies should consider their circumstances, such as the nature of their business, the composition and culture of the Board, the structure and workload of Board committees, the significance of ESG issues to the company, and any regulatory expectations.

Management’s Role Management plays a key role in executing on ESG priorities, as determined by the company. Companies may decide to identify how ESG-related responsibilities can be effectively integrated with existing management roles and skill

TCA SMALL BUSINESS FORUM

sets. While not required, and dependent on a company’s size and its level of ESG ambition, a Chief Sustainability Officer (CSO) could be a significant value creator and catalyst for engagement on ESG issues.

Example: The Executive Committee of the CoBank Board of Directors oversees the implementation and oversight of CoBank’s ESG strategy. CoBank appointed a CSO in March 2022 to be the primary, though not exclusive, leader and owner of the bank’s ESG strategy and lead the institution’s ESG efforts at an executive management level. CoBank has also created an ESG Advisory Group, chaired by the CSO, to provide support, guidance, and oversight of the bank’s ESG framework and related initiatives. The bank’s Finance function works closely with the ESG Advisory Group and its CFO and Treasurer are active members of the Group.

Risk Management

While ESG risks have always been present within companies’ portfolios, they’ve recently gained increased stakeholder and investor interest. ESG risks come in many forms: it may not be as simple as incorporating additional risks into your risk policy. ESG risks may impact existing risk areas and can span across the organization. This is why it’s important to take a structured approach to integrating ESG into your existing risk management framework. Environmental Risks Climate risk, which refers to the physical and transition risks related to increased climate variability is one of the main environmental risks that companies are exposed to. Naturerelated risk, including ecosystem degradation and biodiversity loss, can also negatively impact an organization’s reputation and balance sheets.

Social Risks

Organizations which are highly leveraged in companies engaged in unethical practices; or those which result in worker and occupational health & safety concerns/issues; or which

negatively impact the communities in which they operate, could be exposed to liability and reputational damage.

Governance Risks

Poor corporate governance practices, including lack of effective Board oversight or procedures to monitor and control risks, as well as lending or investing to entities which are poorly governed, could adversely affect financial stability and reputation.

Example: CoBank’s Enterprise Risk Management (ERM) group is evaluating both physical and transition climate risks for each of its banking divisions to determine potential impacts to the entity’s loan portfolio. The ERM group has also begun to assess ESG risk as part of CoBank’s annual risk assessment process. CoBank’s Finance function works closely with the ERM group and is actively involved in the bank’s risk assessment process.

Data

Data is a critical element of a comprehensive ESG program. Many stakeholders agree that while the ESG story is important, they also want to see data - data lends credibility to a narrative. Despite its importance, ESG data is one of the more challenging elements of the ESG journey. ESG data may be disparate, may not be readily available or easily accessible, and often may be incomplete. Combined with other challenges, such as navigating the increasing number of data firms attempting to capitalize on ESG, organizations should be thoughtful and intentional about how they intend to approach ESG data. Data can provide insight on your operations and existing ESG activities; it also allows for tracking or benchmarking of progress. Gathering and analyzing data on your activities, performance, and efforts around ESG priority topics can support how you tell your story and demonstrate real impact to the communities you serve.

Data Governance

A strong data governance program can help safeguard companies against data breaches while contributing toward the achievement of strategic goals. ESG data governance refers specifically to the process of managing and controlling the collection, storage, processing, and reporting of ESG data.

Effective ESG data governance involves establishing clear data policies and procedures, assigning responsibilities for oversight and management, ensuring data accuracy and quality, and monitoring data usage and reporting. It also involves implementing data security measures to protect sensitive information and ensuring compliance with relevant regulations. ESG data governance should be considered in tandem with an organization’s overarching data governance strategy.

Example: One example of the need for strong data governance is the calculation and reporting of emissions. CoBank measured its Scope 1 & 2 greenhouse gas emissions using the Greenhouse Gas Protocol framework and offset these emissions by purchasing carbon credits from Truterra, a whollyowned subsidiary of Land O’Lakes. As part of this process, CoBank invested in the related processes to ensure the reporting was repeatable and auditable. Reporting ESG reporting provides an opportunity to tell your ESG story, mitigate risk, stay aligned with market direction and attract investors. Organizations can tell their ESG story externally in numerous ways. Reporting can be specific or broad. Reports can align with a framework or standard or not and can be standalone and general or focused on specific issues. Another option is to integrate ESG initiatives into an annual report.

It can be challenging to navigate the complicated and shifting landscape of ESG reporting frameworks, disclosure standards and norms, and various methodologies of ESG raters and rankers. Disclosure standards and frameworks are for providing a structured approach to guide the disclosure

of sustainability information and a company’s impacts for ESG as well as supporting organizations as they determine what will be included in ESG reports, provide the correct context, and ensure reporting on the most material topics. Reporting frameworks are for collecting standardized information from companies on climate change and natural resources like water and soft commodities as well as supporting organizations in aggregating quantitative or qualitative data and offer a ‘score’ to benchmark against peers.

The Global Reporting Initiative Standards (GRI), the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-related Financial Disclosures (TCFD) are the most commonly used ESG standards and frameworks.

Example: CoBank issued its first Sustainability Report in early 2023, using the report to communicate information representing related efforts and achievements. This report was an evolution of the prior Corporate Social Responsibility reporting and enhanced our transparency about our social, economic and environmental impact and provided greater insight into our overall sustainability programs and processes. Among other things, the report summarizes actions CoBank has taken to reduce the environmental impact of its operations, including purchasing renewable energy credits (RECs) for a large portion of the bank’s energy consumption, establishing a LEED Silver certified headquarters building, maintaining a bank-wide recycling program, beginning to acquire hybrid vehicles for the bank’s business fleet and providing unlimited transit passes to all bank associates. The Sustainability Report can be accessed at www.cobank.com. Additionally, Finance worked with HR to compile and include in CoBank’s 2022 annual report a limited number of workforce diversity metrics as well as an overview of the bank’s human capital plan and strategies.