The Cooperative Accountant - Winter 2018

Winter 2018 | The Cooperative Accountant

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CONTENTS FEATURES

3 From the Editor

By Frank M. Messina, DBA, CPA

5 Artificial Intelligence (AI): Its Impact to Accountants, and to Electric Cooperatives

By Peggy Boldissar

12 ACCTFAX Bulletin Board

By Phil Miller

18 TAXFAX

By George W. Benson, Teresa H. Castanias, CPA, Christopher R. Duggan and Daniel R. Schultz

25 Small Business Cooperative Forum: Creating a Learning Culture in the Accounting Department

By Barbara A. Wech

31 Section 1383: What Tax Practitioners Need to Know About Cooperatives

By Steve Schroeder, CPA, MBA

EXECUTIVE COMMITTEE

82 ––––––––––– EXECUTIVE COMMITTEE AND NATIONAL DIRECTORS –––––––––––––

PRESIDENT: *William Miller, CPA (806) 747-3806 82 ––––––––––– EXECUTIVE COMMITTEE AND NATIONAL DIRECTORS ––––––––––––– Electric Co-op Chapter bmiller@bsgm.com Bolinger, Segars, Gilbert & Moss, LLP 8215 Nashville Avenue PRESIDENT: Lubbock, TX 79423 *William Miller, CPA (806) 747-3806 ElectricCOMMITTEE Co-op Chapter bmiller@bsgm.com 82 ––––––––––– EXECUTIVE AND NATIONAL DIRECTORS ––––––––––––– Bolinger, Segars, Gilbert & Moss, LLP VICE PRESIDENT: 8215 *NickNashville Mueting Avenue (620) 227-3522 PRESIDENT: Lubbock, 79423 Mid-West TX Chapter nickm@.lvpf-cpa.com *William Miller, CPA (806) 747-3806 82 ––––––––––– EXECUTIVE COMMITTEE AND NATIONAL DIRECTORS ––––––––––––– Lindburg, Vogel, Pierce, Faris, Chartered Electric Co-op Chapter bmiller@bsgm.com P.O. Box 1512 Bolinger, Segars, Gilbert & Moss, LLP VICE PRESIDENT: Dodge City, KS 67801 8215Mueting Nashville Avenue *Nick (620) 227-3522 PRESIDENT: Lubbock,Chapter TX 79423 Mid-West nickm@.lvpf-cpa.com *William Miller, CPA (806) 747-3806

President William Miller, CPA Electric Co-op Chapter Bolinger, Segars, Gilbert & Moss, LLP (806) 747-3806 bmiller@bsgm.com

Vice President Nick Mueting Lindburg, Vogel, Chapter Pierce, Faris, Chartered bmiller@bsgm.com Electric Co-op SECRETARY-TREASURER: Mid-West Chapter P.O. Box 1512 Bolinger, Segars, Gilbert & Moss, LLP *Dave Antoni (267) 256-1627 VICE PRESIDENT: Dodge City, KS Vogel, 67801 Lindburg, Chartered 8215 Nashville Avenue Pierce, Faris, Capitol Chapter dantoni@kpmg.com *Nick Mueting (620) 227-3522 Lubbock, TX 79423 KPMG, LLP (620) 227-3522 Mid-West Chapter nickm@.lvpf-cpa.com 1601 Market St. Lindburg, Vogel, Pierce, Faris, Chartered SECRETARY-TREASURER: nickm@.lvpf-cpa.com Philadelphia, PA 19103 P.O. Box 1512 *Dave VICE Antoni PRESIDENT: DodgeChapter City, KS 67801 Capitol *Nick Mueting

(267) 256-1627 dantoni@kpmg.com (620) 227-3522 KPMG, LLP Chapter Mid-West nickm@.lvpf-cpa.com IMMEDIATE PAST PRESIDENT: 1601 MarketVogel, St. Pierce, Lindburg, Faris, Chartered (608) 662-8600 *Jeff Brandenburg, CPA, CFE SECRETARY-TREASURER: Philadelphia, PA 19103 P.O. Lakes Box 1512 Great Chapter jeff.brandenburg@cliftonlarson *Dave Antoni (267) 256-1627 Dodge City, KS 67801 ClifftonLarsonAllen LLP Capitol Chapter dantoni@kpmg.com 8215 Greenway Boulevard, Suite 600 KPMG, LLPPAST PRESIDENT: IMMEDIATE Middleton, WI 53562 1601 Market St. CPA, CFE *Jeff Brandenburg, (608) 662-8600 SECRETARY-TREASURER: Philadelphia, PA 19103 Great Lakes Chapter jeff.brandenburg@cliftonlarson *Dave Antoni (267) 256-1627 *Indicates Executive Committee Memberdantoni@kpmg.com ClifftonLarsonAllen LLP Capitol Chapter

Secretary-Treasurer Dave Antono Capitol Chapter KPMG, LLP (267) 256-1627 8215 Greenway KPMG, LLP Boulevard, Suite 600 IMMEDIATE PAST PRESIDENT: NATIONAL dantoni@kpmg.com Middleton, WI 53562 1601 Market St. OFFICE

Brandenburg, CPA, CFE (608) 662-8600 Kim Fantaci, Executive *Jeff Director 136 S. Keowee Street Philadelphia, PA 19103 Great Lakes Chapter jeff.brandenburg@cliftonlarson Jeff Roberts, Association Executive Dayton, Ohio 45402 *Indicates Executive Committee Member ClifftonLarsonAllen LLP Tina Schneider, Chief Administrative Officer info@nsacoop.org 8215 Greenway Boulevard, Suite 600 IMMEDIATE PAST PRESIDENT: NATIONAL OFFICE Krista Saul, Client Accounting Manager Middleton, WI 53562 *Jeff Brandenburg, CPA, CFE (608) 662-8600 KimErlenbush, Fantaci, Executive Director 136 S. Keowee Street Bill Director Great of Education Lakes Chapter jeff.brandenburg@cliftonlarson Jeff Roberts, Association Executive Dayton, Ohio 45402 Phil Miller, Assistant Director of Education ClifftonLarsonAllen LLP *Indicates Executive Committee Member THE COOPERATIVE ACCOUNTANT Winter 2018 Tina Schneider, Chief Administrative Officer info@nsacoop.org 8215 Greenway Boulevard, Suite 600 Middleton, WI 53562 OFFICE Krista Saul, Client Accounting Manager NATIONAL

Immediate Past President Jeff Brandenburg, CPA, CFE Great Lakes Chapter CliftonLarsonAllen LLP Bill Erlenbush, Director ofDirector Education Kim Fantaci, Executive 136 S. Keowee Street (608) 662-8600 *Indicates Executive Committee Member Phil Assistant Director of Education JeffMiller, Roberts, Association Executive Dayton, Ohio 45402 jeff.brandenburg@cliftonlarsonallen.com THE COOPERATIVE ACCOUNTANT Winter 2018 Tina Schneider, Chief Administrative Officer info@nsacoop.org NATIONAL OFFICE Krista Saul, Client Accounting Manager Kim Fantaci, Executive Director Bill Erlenbush, Director of Education Jeff Roberts, Association Executive Phil Miller, Assistant Director of Education Tina Schneider, Chief Administrative Officer THE COOPERATIVE ACCOUNTANT

136 S. Keowee Street Dayton, Ohio 45402

info@nsacoop.org For a complete listing of NSAC’s Krista Saul, Client Accounting Manager National Board of Directors and Bill Erlenbush, Director of Education Phil Miller, Assistant Director of Education Committees, visit

National Society of Accountants for Cooperatives 2

THE COOPERATIVE ACCOUNTANT

www.nsacoop.org.

Winter 2018

Winter 2018

Winter 2018 | The Cooperative Accountant

From the

Editor

Frank M. Messina, DBA, CPA Alumni & Friends Endowed Professor of Accounting UAB Department of Accounting & Finance (205) 934-8827 • fmessina@uab.edu

While many of us roll up our sleeves and work everyday – we cannot help but follow the daily folly that is taking place regarding politics in our country. History has shown there have always been “interesting” things going on, but today’s overwhelming technologically driven, social media society use of he said/she said is beginning to re-shape our views and people - more and more are “taking sides.” Our country is not about taking sides against each other – it is about what we are all about – Cooperation. Hopefully, light will shine on that magical word “Cooperation” soon.

Please note in the Fall 2018 Issue, the article in the Small Business Coop Forum section entitled “More than Just Money: Overcoming Generational Woes to Retain Internal Accountants in a Competitive Economy” should be listed in the following corrected authorship order - Key, Edmondson, and Dolowitz.

Remember, we too are always looking for you to share your knowledge (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 reflet the official postion of he 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 Dayton, Ohio 45402. Second-class postage paid at Dayton, Ohio and at additional mail offices. 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 at university libraries, government agencies and other libraries (where there is already a current member) at a rate of $90.00 a year. International subscriptions are $110 a year. Land Grant colleges may receive a complimentary copy. Single copies are avaiable at a rate of $25.00 an issue. Postmaster: send address changes to National Society of Accountants for Cooperatives, 136 South Keowee Street, Dayton, Ohio, 45402.

Winter 2018 | The Cooperative Accountant

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By Peggy Boldissar

What is AI? Merrian-Webster (n.d.) defines AI as: 1 : a branch of computer science dealing with the simulation of intelligent behavior in computers 2 : the capability of a machine to imitate intelligent human behavior MTI College (2018) describes what AI technologies do. AI allows machines (bots) to learn from experience, interpret information, make adjustments and apply what they “know” to perform humanlike tasks. ● Machine learning gives computers the ability to recognize and apply patterns to develop algorithms that they can then fine-tune based on feedback; an example is the way Netflix can offer you suggestions of what to watch based on your viewing history. ● Through deep learning, computers develop the ability to identify relationships and associations. ● When machines “understand” information, they can actually “think” of the implications of that data and analyze it with machine reasoning. ● Computers use natural language processing based on their understanding of human speech. ● They “recognize” people, activities and 4

objects, and “view” images with computer vision; an example is the way the iPhone X recognizes the face of its user.

Johnston (2018) writes that: AI has matured from technology buried in computer science labs using complex coding techniques to more common algorithms and supporting technologies used as part of the design strategy of new generation products.

Many of the developers have known of AI techniques for years but did not have a practical way to apply the algorithms because the compute overhead was too high, the sample of data was too small and the number of techniques that needed to be applied made the code too complex. With centralized computing in SaaS applications and cloud data centers, AI has become much more practical and accurate.

Johnston further describes how AI approaches work. They use: ● Cybernetics and brain stimulation – connection to neurology . ● Traditional symbolic AI – John Haugeland named these approaches to AI “good old fashioned AI” or “GOFAI” exploring the possibility that human intelligence could be reduced to symbol manipulation. ● Cognitive simulation – Economist Herbert Winter 2018 | The Cooperative Accountant

Artificial Intelligence (AI) Simon and Allen Newell studied human problem-solving skills from psychological experiments resulting in the Soar architecture in the 1980’s. ● Logic-based – John McCarthy in his laboratory at Stanford (SAIL) used formal logic and led to the Prolog language and the science of logic programming. ● Anti-logic or scruffy – Marvin Minsky and Seymour Papert found that solving difficult problems in vision and natural language processing required ad-hoc solutions. ● Knowledge-based – led to the development in the 1970’s of expert systems, introduced by Edward Feigenbaum of Stanford. ● Sub-symbolic – when traditional symbolic AI stalled in the 1980’s was unable to solve problems in perception, robotics, learning and pattern recognition, researchers tried to not encode knowledge. ● Embodied intelligence – Researchers of robotics, such as Rodney Brooks, reintroduced the use of control theory and embodied mind. ● Computational intelligence – neural networks and “connectionism” was revived by David Rumelhart leading to soft computing approaches including fuzzy systems, evolutionary computation and statistical tools. ● Statistical methods – sophisticated mathematical tools to solve specific subproblems that are truly scientific, in the sense that their results are both measurable and verifiable. ● Intelligent agent – a system that perceives its environment and takes actions which maximize its chances of success.

The strengths of AI technologies lie in their ability to process information effectively for large data volumes and complex and changing patterns. And, they are able to do this with consistency, without tiredness, boredom, or biases exhibited by human counterparts. Parsons (2018) notes that AI is not only software that can draw conclusions from large quantities of data and adjust its activities based on those conclusions, but it’s also a system that can learn quickly in real time and be applied to an entire organization (para. 1).

AI does have some limitations. Not every problem or decision is suitable for a machine learning approach. For example, there needs to Winter 2018 | The Cooperative Accountant

be a degree of repeatability about the problem or question so that an automated AI program can generalize its learning and apply it to other cases.

For unique or novel questions, the output may be far less useful. The outputs of machine learning models are predictions or suggestions based on mathematical calculations, and not all problems can be resolved in this way. Other considerations may need to be factored into decisions, such as ethical questions, or the problem may require deeper root cause analysis. Some decisions are best made within some context, and AI cannot always deal well with context. Another instance where AI may not be the best application is when not all of the right data is available for program analysis. Success with AI comes when data is sufficient and of the right quality.

How is AI impacting accountants and the accounting profession?

The world of accounting is just the latest in a series of industries being affected by the rapid increase in the use of AI. The Institute of Chartered Accountants in England and Wales (ICAEW) is a member of Chartered Accountants Worldwide (CAW), which brings together 11 chartered accountancy bodies, representing over 1.6m members and students globally. They have described the human decision-making process as follows: Human Decision-Making: Humans make decisions in two different ways Institution Much of our thought process is instinctive and unconscious, taking place very quickly and with little effort. This type of thinking is rooted in recognizing patterns based on what has happened before, and is often described as intuitive.

Reasoning We also use logic and reason in order to answer questions and make decisions. This conscious process uses our knowledge and typically takes over when intuition has not produced a satisfactory answer.

This process takes time and effort.

ICAEW goes on to further explain: Accountants, as expert decision makers, use both ways of thinking – they apply their knowledge to specific situations to make reasoned decisions, 5

Artificial Intelligence (AI) but also make quick intuitive decisions based on extensive experience in their field. Our intuitive thinking is particularly powerful, reflecting quick learning and high levels of flexibility. It provides the foundation for our language, vision, sensing, understanding of the everyday world and ways of interacting with others. However, it is not perfect.

It is subject to many biases and inconsistencies, explored in detail by psychologists such as Daniel Kahneman. ● Availability bias – more recent or common examples tend to come to mind, which can skew our decision-making processes. ● Confirmation bias – we tend to see only things that are consistent with our existing views. ● Anchoring – we are strongly influenced by prior suggestions.

It could be that we are at a time in history where how we store and access financial information coupled with maturing technology capabilities will accelerate the digital transformation of our accounting profession. As machines continue to advance technologically, taking on more and more repetitive and timeconsuming tasks, human accounting resources are being freed up to do higher level (and hopefully more lucrative) work for their employers or clients.

Su (2018) writes in a recent Forbes article that “in our upcoming research report on the future of accounting, we expect that by 2020, accounting tasks - but also tax, payroll, audits, banking… - will be fully automated using AIbased technologies, which will disrupt the accounting industry in a way it never was for the last 500 years, bringing both huge opportunities and serious challenges” (para. 5). Su notes that the accuracy of the machine learning algorithms used in most of today’s solutions still needs to significantly improve in efficiency to avoid accounting errors and really fulfill their promise of automation. But, most agree that it is just a matter of time until those improvements are made and available to the masses at affordable costs.

Some of the opportunities that may be associated with this digital transformation include: ● Accountants should be able to handle more work or clients, and deliver added value as they can provide actionable insight rather than

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just be a number cruncher. ● Automating accounting processes will also help improve operations and reduce costs. ● The cost of AI technologies is becoming increasingly more affordable to small and midsize companies, not just larger organizations.

This will continue to be the case as time progresses.

Some of the areas where AI is already making a difference in improving operations and reducing costs are illustrated by the following examples: ● Accounts payable/receivable processing: There are already AI-powered invoice management systems available that can make invoice processing much more streamlined thanks to digital workflows that are implemented.

They can learn the accounting codes that are appropriate for each invoice. ● Supplier onboarding: Machines can vet new suppliers by checking their credit scores or tax information and set them up in the system without human involvement and even query portals to get all the necessary information. ● Procurement: The procurement and purchasing processes for most organizations are filled with paperwork and use different systems and files that are not compatible with one another. As machines through APIs are able to be integrated and the unstructured data is processed, the procurement system will eventually become paperless. Robots are ideally suited to tracking price changes among a number of suppliers. ● Audits: Digitalization of the audit process will help increase its security by allowing a digital trail of when and by whom each file was accessed. Instead of searching file cabinets for the documentation that is required during an audit, auditors will be able to leverage the digital files. A more digital audit improves the efficiency and accuracy of audits and makes an audit of 100% of a company’s financial transactions possible instead of just a sample. ● Monthly/quarterly close process: The faster one can get the numbers, the more time the organization has to think strategically about what to do with the numbers. Machines can post data from a number of sources, consolidate and reconcile it. Not only will Winter 2018 | The Cooperative Accountant

Artificial Intelligence (AI) the monthly/quarterly close process be speedier, it will also be more accurate thanks to the support of machines in the process.

Additionally, technology for generating and processing natural language can turn financial tables into written documents, give structure to large volumes of unstructured financial data, and pore through long documents and contracts to extract needed information. ● Expense management: Reviewing and approving expenses to ensure they are compliant with an organization’s policies is time-consuming for an accounting team.

Machines can read receipts, audit expenses and alert humans when a possible infraction has occurred. ● AI chatbots: Chatbots are used to efficiently solve common questions or queries. For example, AI chatbots from customers can include the latest account balances, when certain bills are due, the status on accounts and more.

Charpentier (2018) discussed the latest advancements using AI in Accounts Payable (AP).

Before AI, accounting teams manually created and processed invoices, purchase orders, or delivery orders on paper documents.

Those documents were then manually entered in computer systems, coded, and finally transmitted to the managers for approval and payment. Today, thanks to AI, there are no more manual processes! The AP workflow process is automated by software that analyzes, recognizes, directs, and exports data into a company’s ERP/financial system. Before automating the AP workflow, suppliers had little to no insight into payment timing details; now, they have full access to this information in real time.

The advancements in AP automation have been powered by the following technology deployments: ● Algorithms have become more and more reliable, flexible, and adaptable, permitting solutions to automatically manage documents with variable structure, such as invoices. As a result, data is automatically recognized in an exhaustive and reliable way, with no prior configuration.

Winter 2018 | The Cooperative Accountant

● Cloud solutions are available to millions of users, which results in constant technological enhancements. This contrasts to older onpremise solutions where usage was limited. ● The self-learning — machine learning — capabilities of cloud-based software solutions are constantly improving. These solutions essentially “learn” from their mistakes and do not make them again once humans correct them.

AI-driven AP programs are increasingly able to: ● Identify and interact with suppliers; ● Automatically intake, code, process and route invoices, using optical recognition technology; and, ● Denote payment deadlines, approval workflows, and the approvers.

Everatt (2018) notes that Gartner research predicts that by 2022, 80 percent of smartphones shipped will have on-device AI capabilities. This change is set to impact accountants and very quickly the industry will see the implementation of optical character recognition (OCR) technology. We’ll also see more intelligence from smartphones when performing functions. For instance, he notes, if an employee is driving, the smartphone might prompt the user to see if they would like to make a claim for their mileage, or auto populate an expense claim by scanning a receipt.

For auditors, who perform audits of financial records, they can access AI tools with natural language processing capabilities to interpret thousands of bits of information. The technology can extract key terms and compile and analyze that information to perform risk assessments or other functions that are vital to creating and executing audit plans. Additionally, these tools can perform a variety of analyses, designed by humans, and then provide lists of exceptions for the auditor to evaluate. Machine learning comes into play as the auditor confirms the exception or invalidates that exception and the machine learns to “look” at the auditor’s conclusions and try to identify additional data points about the positives or negatives to apply to additional exceptions it identifies. In this way it learns to better identify exceptions. The auditor role, for both internal and external auditors, will switch from performance of the procedures to design of the procedures, interpretation of the results, and 7

Artificial Intelligence (AI) monitoring the effectiveness of the interpretation.

While AI technologies are fairly wide-spread in use, there has been limited use of some AI technologies within the accounting industry.

These include things such as: 1. using machine learning to code accounting entries and improve on the accuracy of rules-based approaches, enabling greater automation of processes; 2. improving fraud detection through more sophisticated, machine learning models of ‘normal’ activities and better prediction of fraudulent activities; 3. using machine learning-based predictive models to forecast revenues; and 4. improving access to, and analysis of, unstructured data, such as contracts and emails, through deep learning models.

Expectations are for technology improvements to be deployed in these areas in the future.

AI’s impacts to electric cooperatives AI and the energy industry are not mutually exclusive. In fact, they are becoming increasingly interconnected as computing power, data collection, and storage capabilities scale exponentially on an annual basis. The advances in both industries offer opportunities to meld new technologies to improve the performance in both arenas. AI technologies are still in their early stages of development and implementation, and the future expectations are that they will be poised to revolutionize the way energy is produced, transmitted, and consumed.

Wolfe (2018) notes that an added benefit of AI is its ability to limit the energy industry’s environmental impacts at a time when “demand is steadily growing, our energy production portfolio is diversifying, and we are witnessing the ramifications of fossil fuel consumption on biodiversity, air quality, and quality of life” (para.

3).

The mission of the utility industry, including electric cooperatives, is to produce and transmit power under a mandate of low-cost, reliable energy as a public good. The utility grids in the US were constructed decades ago, with many current systems averaging 30 to 40 years old.

The current challenge in the industry is the rise of distributed generation, where private sector users are generating and using their own energy from renewable sources (i.e. wind or solar). In 8

balancing the past grid investments with the deployments of present energy technologies, AI may help to bridge the gap in providing information regarding supply and demand requirements on power systems. The older grids were not built with the new emerging energy technologies in mind at the time. The energy industry is currently in a transformation period working to adapt and incorporate the new energy technologies into existing energy portfolios. With the influx of smart grid technologies, as mandated by the US Department of Energy, the energy industry has been working over the last decade towards a more automated power delivery network that monitors and controls consumption by customers. The capture of automated meter data in smart meters will be a prime example of where AI technologies can be merged with large amounts of consumption data collected by these smart meters in order to better manage load requirements. If the smart grid is able to use fossil fuels in the most efficient way possible through increased incorporation of renewable resources as those technologies advance in sophistication and capability, the entire system may be able to reduce its carbon footprint. On the supply side, AI could allow the transition to an energy portfolio with increased renewable resource production and help to minimize disruptions that come variability in sunlight and wind intensity.

One of the major concerns with the smart grid is the increased use and reliance on the internet and computer processing power.

The computer industry has become a large contributor of greenhouse gas emissions in recent years as companies shifted to machinerun operations, and the use of the internet has increased dramatically. With the increase in the capture of large amounts of data from customers’ smart meters, additional computer machines and computing power will be needed. As a result, the impact of energy consumption on the environment from further greenhouse gas emissions will likely continue to increase. Players in the AI energy grid industry will need to address this problem. Industry leaders have been aware of this challenge and have been taking steps to address this. Interestingly, the three leading greenhouse gas emitters in this industry are computer makers, data centers, and telecoms.

One example of how this issue is being addressed is that computer makers are investing in new Winter 2018 | The Cooperative Accountant

Artificial Intelligence (AI)

hard drives, screens, and fuel cells; data centers are monitoring temperatures, pooling resources and researching cloud computing; and telecoms are looking into network optimization packages, solar-powered base stations, and fiber optics (Wolfe, 2018, para. 15).

AI is continuing to make inroads in the energy industry. Some of the use cases for AI include: ● Consumer energy efficiency - AI can track household behaviors and feed smart thermostats. This could result in devices that learn the habits of the household occupants and adjust temperatures automatically to accommodate them. ● Storage - Smart storage applications can make pulling energy from sources more intuitive. This could result in devices that track behavioral data like peak demand and lows to figure out how fast battery storage should charge, or when to dispatch energy, and how much energy it should store. ● Automating Grids - Grids can respond to fluctuations in demand, peaks and lows, and meet them when it’s most necessary.

Additionally, utilities could control many processes and equipment remotely. This means, though, that the network they operate on could be vulnerable to attacks.

Summary It will be the effective pairing of people and machines that provide for the most valuable deployment of an organization’s resources, allowing each to contribute in the areas where Winter 2018 | The Cooperative Accountant

they are best suited.

Machines can handle a high volume of information rapidly, and identify and quantify patterns in data which could speed up decisionmaking or problemsolving. It will fall on people to be the ultimate decisionmakers and problemsolvers, as no machine has yet been able to replace certain value added activities performed by people.

Present-day AI technologies have yet to mirror a human’s ability to handle decision making based upon context.

Accountants will continue to notice this transition from task-driven activities to one of empowerment in which systems driven

by AI are in charge of the data entry, data verifications, referrals, and fraud detection.

With this continuing technological transition, accountants’ time will be increasingly freed up to produce “real added value with time for analysis, strategy, creative thinking, and decision-making” (Charpentier, 2018, para. 11). Professional accountants do much more than keep track of receipts and provide basic reports, they act as consultants who advise on tax planning, discuss operations, and review employer and client goals and more. Additionally, the rapid pace of change in client industries and the expansion of complicated regulations means that human controller services will be necessary to ensure that compliance requirements are met and financial controls are sound AI is largely being used to digest and analyze large volumes of data at speeds well beyond what any person or team of people could do.

Experts generally believe that some accounting jobs could be lost as machines continue to take over more and more automated tasks, but most believe that the net impact to jobs available for accountants will be negligible. Some even believe that accountants may be in more demand. The biggest impact will be the shifting of work duties from less sophisticated to more 9

Artificial Intelligence (AI) sophisticated or complex work. Everatt (2018) contends that “Accountants are now able to use the time saved through AI-based technologies to add insight to the information provided and increase value, allowing them to move towards more legislative and compliance-orientated tasks” (para. 11). Although AI technologies are not new, and the pace of change is fast, widespread adoption in business and accounting is still in its early stages. While accountants have been using technology for many years to improve what they do and deliver more value to their employers and clients, emerging AI technologies present an opportunity to reimagine and radically improve the quality of business decisions.

The recommendation to company management is to form a strategy for AI technology deployment in their organization’s strategic plans because AI isn’t coming, it’s already here. Parsons points out that “the difference between leading a financial services team toward new, technological opportunities – or obsolescence – is in the strategic focus of leadership” (para. 2). Some of the areas of focus recommended for management might include imagining how AI can help better serve the organization’s mission, exploiting powerful technologies, thinking radically, and remaining adaptable to change as it becomes warranted.

The recommendation for accountants and auditors is to gain database and IT skills by taking on special projects or work assignments, attending seminars, and completing classes or self-directed learning to learn about latest technologies. It is important for them to stay upto-date on the latest accounting trends, emerging technologies and industry news. Accountants need to learn not to rely on AI tools blindly, but instead be able to critically analyze and spot important information produced from automated tools. The AI evolution will also be reflected in the skills required of accountants. Some roles may require deep knowledge of machine learning techniques, but other roles may just need a more superficial knowledge of machine learning to be able to have informed conversations with experts and other parts of their organization. Either way, critical thinking and communication skills are likely to become increasingly more important. The role of the accountant could change into a managerial position where technology will increase the accuracy and efficiency of work freeing up 10

accountants to take on a partnership role with other areas of the business.

Accounting regulators and standard setters also need to build their understanding of the application of AI technologies and be comfortable with any associated risks. The recommendation is that standard setters and regulators take a proactive approach to understanding AI and how it is being deployed by accountants. For example, standard setters in audit will want to examine where auditors are using these techniques to gain evidence, and understand how reliable the techniques are. If organizations and audit firms increasingly rely on AI models in their operations, more thinking will be required about how these regulators and standard setters gain comfort in their correct operation. Regulators can also actively encourage and even push adoption where it is aligned to their requirements.

References CBInsights. (March 8, 2018). 5 Ways The Energy Industry Is Using Artificial Intelligence. Retrieved November 7, 2018 from https://www.cbinsights. com/research/artificial-intelligence-energyindustry/ Charpentier, L. (July 25, 2018). Voices From artificial intelligence to accounting intelligence.

Retrieved November 7, 2018 from https://www. accountingtoday.com/opinion/from-artificialintelligence-to-accounting-intelligence Everatt, N. (July 20, 2018). Will AI help or hinder the future of accountancy? Retrieved November 7, 2018 from https://www. accountancyage.com/2018/07/20/will-ai-help-orhinder-the-future-of-accountancy/ Institute of Chartered Accountants in England and Wales (ICAEW), IT Faculty. (2017). Artificial intelligence and the future of accountancy.

Retrieved November 7, 2018 from https://www. icaew.com/-/media/corporate/files/technical/ information-technology/technology/artificialintelligence-report.ashx?la=en Johnston, R. (May 22, 2018). What AI Means for the Accounting Profession: Part II. Retrieved November 7, 2018 from https://www. cpapracticeadvisor.com/article/12407031/what-aimeans-for-the-accounting-profession-part-ii Marr, B. (June 1, 2018). The Digital Transformation Of Accounting And Finance Artificial Intelligence, Robots And Chatbots.

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Artificial Intelligence (AI) Retrieved November 7, 2018 from https://www. forbes.com/sites/bernardmarr/2018/06/01/ the-digital-transformation-of-accountingand-finance-artificial-intelligence-robots-andchatbots/#2ba1024f4ad8 Merrian-Webster Dictionary. (n.d.). Definition of artificial intelligence. Retrieved November 7, 2018 from https://www.merriam-webster.com/ dictionary/artificial%20intelligence MTI College. (August 15, 2018). How Artificial Intelligence (AI) Impacts Accounting. Retrieved November 7, 2018 from https://mticollege.edu/ artificial-intelligence-accounting/ Najjar, D. (July 15, 2018). Is Artificial Intelligence (AI) the Future of Accounting?

Retrieved November 7, 2018 from https://www. thebalancesmb.com/is-artificial-intelligence-thefuture-of-accounting-4083182 Parsons, S. (July 31, 2018). How AI and Automation Technology Can Help Accountants.

Retrieved November 7, 2018 from https://www. business.com/articles/ai-and-accounting/ Su, J.B. (January 22, 2018). Why Artificial Intelligence Is The Future Of Accounting: Study.

Retrieved November 7, 2018 from https://www. forbes.com/sites/jeanbaptiste/2018/01/22/whyartificial-intelligence-is-the-future-of-accountingstudy/#571c5191337b Wolfe, F. (August 28, 2018). How Artificial Intelligence Will Revolutionize the Energy Industry. Retrieved November 7, 2018 from http://sitn.hms.harvard.edu/flash/2017/artificialintelligence-will-revolutionize-energy-industry/ Articles of Interest Harris, J. (August 9, 2018). Is Artificial Intelligence Set to Replace Accountants in the Future?

Retrieved November 7, 2018 from https://finance. toolbox.com/articles/is-artificial-intelligence-setto-replace-accountants-in-the-future KDP Certified Public Accountants, LLP. (June 1, 2018). The Effects of AI on Accounting.

Retrieved November 7, 2018 from https://www. kdpllp.com/the-effects-of-ai-on-accounting/ Kubicki, F. (August 14, 2018). AI in Accounting: How Artificial Intelligence & Machine Learning Technology Has Changed the Industry.

Retrieved November 7, 2018 from https://www. intellichief.com/ai-in-accounting/ Mohamandi, T. (September 28, 2018). What accountants can learn from AI. Retrieved November 7, 2018 from https://accountingweekly.

Winter 2018 | The Cooperative Accountant

com/what-can-accountants-learn-from-ai/ Mooney, G. (May 17, 2018). 10 Ways Utility Companies Can Use Artificial Intelligence And Machine Learning. Retrieved November 7, 2018 from https://www.digitalistmag.com/ digital-economy/2018/05/17/10-ways-utilitycompanies-can-use-artificial-intelligence-machinelearning-06167501 Ovaska-Few. (October 10, 2017). How artificial intelligence is changing accounting.

Retrieved November 7, 2018 from https://www. journalofaccountancy.com/newsletters/2017/oct/ artificial-intelligence-changing-accounting.html Shimamoto, D.C. (April 8, 2018). Why Accountants Must Embrace Machine Learning.

Retrieved November 7, 2018 from https://www. ifac.org/global-knowledge-gateway/technology/ discussion/why-accountants-must-embracemachine-learning Warawa, J. (November 1, 2017). Here’s Why Accountants (Yes, YOU!) Should Be Driving AI Innovation. Retrieved November 7, 2018 from https://www.cpapracticeadvisor.com/ news/12378218/heres-why-accountants-yes-youshould-be-driving-ai-innovation UTILITY COOPERATIVE FORUM General Editor Peggy Boldissar LCEC (Lee County Electric Cooperative, Inc.) Manager, Financial Accounting PO Box 3455 North Fort Myers, FL 33918-3455 Phone (239) 656-2117 Fax (239) 656-2256 peggy.boldissar@lcec.net

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GENERAL EDITOR Philip W. Miller NSAC Assistant Education Director (804) 339-9577 pwm01@comcast.net ASSISTANT EDITORS Greg Taylor Williams & Company 806) 785-5982 gregt@dwilliams.net

By Phil Miller, NSAC Assistant Education Director

WARNING: IT’S CRUNCH TIME FOR PRIVATE COMPANIES ON REVENUE RECOGNITION We have been talking about the new Revenue Recognition standard for several years now.

We pointed out that private companies (most of us) got additional time to implement the standard. But, guess what? It is now crunch time!!

The November 2018 issue of The Journal of Accountancy provides some valuable insight into the task ahead.

“It’s understandable that FASB’s new revenue recognition standard might not be top-of-mind for private company finance personnel despite the impending effective date. The standard takes effect for private companies for annual reporting periods beginning after Dec. 15, 2018, and interim periods within fiscal years beginning after Dec. 15, 2019. So effectively, private companies must adopt by the 2019 year end. That doesn’t give them much time to work on implementation, but it’s still easy for them to overlook the importance of this new standard.”

Private company leaders are running out of time to comply with this significant new standard.

The most important thing, of course, is to get started. After that, advises the Journal, here’s what private companies can do to make sure they’re able to make an effective transition to the new standard.

“Identify your “point person.” Your organization needs somebody in charge of this implementation to make sure it gets done correctly. That’s likely to be someone from the finance department.

It’s also important to make sure this person 12

Bill Erlenbush Education Director (309) 530-7500 nsacdired@gmail.com

has the support of people from operations, sales, legal, and other departments to help the implementation go smoothly.

Determine the resources you will need.

Will your point person be able to handle this implementation alone? Will it be necessary to get other help, perhaps from consultants or temporary accounting services? You need to make sure you have the right people to do this job.

Develop a timeline. A well-organized set of milestones, roles, responsibilities, and accountabilities will help you make orderly progress.

Scrutinize your contracts. The information in your contracts is the key to complying with the five-step revenue recognition process described in the new standard. In some cases, this close examination of your contracts may show you improvements that can be made in operations.

For instance, if you find that certain contracts are losers from a revenue perspective, you may choose to renegotiate them.

Evaluate systems. “Do I have those controls in place, and am I able to implement this? And on top of that, you have to look at, ‘Does my accounting system give me the ability to do this?’”

If your system can’t do the job, it may be time for an upgrade.

Create strong controls over adoption. If your adoption processes are not airtight, you will be susceptible to problems later.

Winter 2018 | The Cooperative Accountant

ACCTFAX Pick the right transition method. In many cases, the modified retrospective version will be easier for companies to implement. But the full retrospective transition will provide investors and others with more of the information they need to compare the past to the present.

Pay close attention to disclosures. One of the principal goals of the revenue recognition standard was to provide investors with more disclosures and useful information than in the past. It’s important to make sure your systems capture the right data to enable those disclosures to be made correctly.”

All this implementation work will be a significant task for some private companies. And with 2019 just a couple months away, ignoring this task now may lead to a lot of angst for companies next year.

RELATED: FASB STAFF PAPER PROVIDES EDUCATIONAL EXAMPLES OF REVENUE RECOGNITION IMPLEMENTATION FOR PRIVATE COMPANY FRANCHISORS On November 5, 2018, the Financial Accounting Standards Board (FASB) announced the release of an educational FASB staff paper that provides implementation examples to help private company franchisors preparing to implement the revenue recognition standard in 2019.

“Stakeholders asked us to clarify how private company franchisors should recognize certain franchise fees when the revenue recognition standard takes effect next year,” stated FASB Chairman Russell G. Golden. “In response to their requests, the FASB staff prepared an educational paper that provides illustrations that should help these stakeholders successfully implement the standard.”

The FASB staff paper primarily targets questions related to the use of judgment in identifying performance obligations. Under current accounting guidance, a franchisor typically recognizes an initial franchise fee when a new franchise location opens. Consequently, the franchisor has not had to assess whether preopening services are a separate deliverable.

Winter 2018 | The Cooperative Accountant

Under the new revenue recognition guidance, the franchisor will be required to determine if the preopening activities contain any distinct goods or services. To help franchisors transition to the new guidance, the FASB staff paper provides educational illustrations of how a franchisor may make these assessments.

“The FASB staff paper is one of many examples of how we’re continually monitoring and supporting the successful implementation of our standards,” added Mr. Golden. “These efforts are made possible by the valuable input provided by organizations like the International Franchise Association and its members, and we thank them for their assistance in ensuring our standards are, in fact, ‘standards that work.’”

“IFA commends the FASB for working with our members to issue educational resources that illustrate how franchise brands should recognize revenue related to initial franchise fees,” said IFA President and CEO Robert Cresanti. “This educational material will help accountants accurately apply the standard and contribute to the financial stability of franchise companies.”

The FASB staff paper, along with complete information about the revenue recognition standard, is available at www.fasb.org.

FASB PROPOSES NARROW-SCOPE IMPROVEMENTS TO CREDIT LOSSES STANDARD On August 20, 2018, the Financial Accounting Standards Board (FASB) issued a proposed Accounting Standards Update (ASU) that would amend the transition requirements and scope of the credit losses standard issued in 2016.

Stakeholders are encouraged to review and provide comment on the proposal by September 19, 2018.

First, the proposed ASU would mitigate transition complexity by requiring entities other than public business entities to implement it for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. This would align the implementation date for their annual financial statements with the implementation date for their interim financial statements.

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ACCTFAX Second, the proposed ASU would clarify that receivables arising from operating leases are not within the scope of the credit losses standard, but rather, should be accounted for in accordance with the leases standard.

More information about the proposed ASU can be found at www.fasb.org.

FASB IMPROVES THE EFFECTIVENESS OF DISCLOSURES IN NOTES TO FINANCIAL STATEMENTS On August 28, 2018, the Financial Accounting Standards Board (FASB) issued two changes to the FASB’s conceptual framework and two Accounting Standards Updates (ASUs) that improve the effectiveness of disclosures in notes to financial statements.

A new chapter in the Conceptual Framework on disclosures.

The chapter explains what information the Board should consider including in notes to financial statements by describing the purpose of notes, the nature of appropriate content, and general limitations. It also addresses the Board’s considerations specific to interim reporting disclosure requirements.

An update to an existing chapter of the Conceptual Framework for its definition of materiality.

The amendment aligns the FASB’s definition of materiality with other definitions in the financial reporting system. The materiality concepts will now be consistent with the definition of materiality used by the U.S. Securities and Exchange Commission, the auditing standards of the Public Company Accounting Oversight Board and the American Institute of Certified Public Accountants, and the United States judicial system.

An ASU on Fair Value Measurement disclosure requirements.

The standard improves the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement. The amendments are effective for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted.

An ASU on Defined Benefit Plan disclosure requirements.

The standard improves disclosure requirements 14

for employers that sponsor defined benefit pension or other postretirement plans. The amendments are effective for fiscal years ending after December 15, 2020, for public companies, and for fiscal years ending after December 15, 2021, for all other organizations. Early adoption is permitted.

More information about the Conceptual Framework changes and the ASUs can be found at www.fasb.org.

LATEST DISCUSSIONS AT FASB’S PRIVATE COMPANY COUNCIL On October 9, 2018, the FASB Private Company Council (PCC) discussed and provided input on the following topics: Consolidation Targeted Improvements to Related Party Guidance for Variable Interest Entities: PCC members were briefed on an additional criterion added by the Board to address concerns raised by some stakeholders that would preclude the private company accounting alternative from being applied to any legal entity in which a private company holds a majority of the legal entity’s voting interest. The PCC did not object to the additional criterion, noting that it should not preclude private companies from applying the accounting alternative to sibling entities under common control.

Leases Implementation: The PCC discussed ongoing lease accounting implementation activities of the FASB. Distinguishing Liabilities from Equity: PCC members broadly supported the FASB’s efforts to simplify the accounting for the issuance of financial instruments with embedded conversion features. Several PCC members stated that current disclosure requirements for these financial instruments are adequate and did not recommend any additional disclosures for convertible instruments.

Disclosure Framework: Disclosure Review – Income Taxes: The PCC discussed the Disclosure Review project relating to Income Taxes, focusing on three main areas: ● Additional disclosures that may be needed as a result of the Tax Cuts and Jobs Act Winter 2018 | The Cooperative Accountant

ACCTFAX ● Disclosures that may no longer be relevant as a result of the Tax Cuts and Jobs Act ● Proposed disclosures that comment letter respondents indicated may not provide relevant information.

Share-Based Compensation: PCC members discussed recent outreach performed with tax, valuation, and legal experts regarding the tax requirements for valuing share-based payments and the other economic factors influencing the strike price in relation to the fair value of the underlying share. The PCC expressed support for a practical expedient to assume the strike price is the fair value of the underlying share when valuing an equity-classified award, subject to certain “guardrails” to prevent entities from abusing the practical expedient. The PCC and Board agreed that the language used in the expedient should be carefully considered to ensure that the intended cost relief is realized when applied in practice.

The next PCC meeting will be held on Tuesday, December 11, 2018, in Norwalk, CT. FASB IMPROVES CONSOLIDATION ACCOUNTING On October 31, 2018, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) that reduces the cost and complexity of financial reporting associated with consolidation of variable interest entities (VIEs). A variable interest entity is an organization in which consolidation is not based on a majority of voting rights.

“Simplifying VIE guidance for private companies is based on recommendations from the Private Company Council (PCC) and addresses stakeholder concerns that it is difficult to apply current consolidation guidance for VIEs under common control,” said Russell G. Golden, FASB chairman. “It provides private companies the choice to not apply VIE guidance to their common control arrangements—thereby reducing costs without compromising the relevance of the financial reporting information to financial statement users.”

Private Company Accounting Alternative The new guidance supersedes the private company alternative for common control leasing Winter 2018 | The Cooperative Accountant

arrangements issued in 2014 and expands it to all qualifying common control arrangements.

Under the new standard, a private company could make and accounting policy election to not apply VIE guidance to legal entities under common control (including common control leasing arrangements) when certain criteria are met. This accounting policy election must be applied by a private company to all current and future legal entities under common control that meet the criteria for applying the alternative. A private company will be required to continue to apply other consolidation guidance, specifically the voting interest entity guidance.

Additionally, a private company electing the alternative is required to provide detailed disclosures about its involvement with, and exposure to, the legal entity under common control.

Decision-Making Fees The standard also amends the guidance for determining whether a decision-making fee is a variable interest. The amendments require organizations to consider indirect interests held through related parties under common control on a proportional basis rather than as the equivalent of a direct interest in its entirety (as currently required in GAAP). Therefore, these amendments likely will result in more decision makers not consolidating VIEs. For organizations other than private companies, the amendments in this ASU are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years.

The amendments in this ASU are effective for a private company for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021.

Early adoption is permitted.

More information about the ASU, including a FASB In Focus overview, can be found at www. fasb.org.

FASB IMPROVES ACCOUNTING FOR COLLABORATIVE ARRANGEMENTS On November 5, 2018, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) that clarifies the interaction between the guidance for certain collaborative arrangements and the Revenue Recognition financial accounting and reporting standard.

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ACCTFAX A collaborative arrangement is a contractual arrangement under which two or more parties actively participate in a joint operating activity and are exposed to significant risks and rewards that depend on the activity’s commercial success. The ASU provides guidance on how to assess whether certain transactions between collaborative arrangement participants should be accounted for within the revenue recognition standard.

The ASU also provides more comparability in the presentation of revenue for certain transactions between collaborative arrangement participants. It accomplishes this by allowing organizations to only present units of account in collaborative arrangements that are within the scope of the revenue recognition standard together with revenue accounted for under the revenue recognition standard. The parts of the collaborative arrangement that are not in the scope of the revenue recognition standard should be presented separately from revenue accounted for under the revenue recognition standard.

For public companies, the amendments in this ASU are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. For all other organizations, the amendments are effective for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. Early adoption is permitted.

More information about the ASU is available at www.fasb.org.

FASAB PROPOSAL SEEKS CLEARER MATERIALITY GUIDANCE The Federal Accounting Standards Advisory Board (FASAB) is asking for public comment on a proposal to clarify the implementation of materiality concepts in the issuance of federal financial statements.

A proposed Statement of Federal Financial Accounting Concepts (SFFAC) titled Materiality, issued Oct. 16 by FASAB, would (1) provide materiality concepts, (2) specify the scope of materiality, and (3) list factors to consider when applying materiality.

“The intent is for clearer materiality guidance to improve the understanding and comprehension of federal financial reports by financial statement users,” FASAB Chairman Scott Showalter said in a news release.

Comments on the exposure draft are due by Jan. 23, 2019. FASAB is encouraging respondents 16

to view the exposure draft and respond to specific questions contained in the document. The ED and the questions are available on the FASAB website at fasab.gov/documents-for-comment.

RELATED: IASB CLARIFIES DEFINITION OF MATERIAL In an effort to make it easier for companies to make materiality judgments, the International Accounting Standards Board (IASB) has issued a clarified definition of “material.”

The definition of materiality is a crucial element in accounting because it helps companies decide whether information is important enough to be included in their financial statements. To clarify the definition, the IASB amended IAS 1, Presentation of Financial Statements, and IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors.

Under the new definition, information is material if omitting, misstating, or obscuring it could reasonably be expected to influence the decisions that the primary users of generalpurpose financial statements make on the basis of those financial statements, which provide financial information about a specific entity.

The old definition stated that omissions or misstatements of items are material if they could, individually or collectively; influence the economic decisions that users make on the basis of the financial statements.

The IASB updated the definition because some companies had difficulty using the old definition.

The amendments are intended to clarify both the definition of material and how the definition should be applied. The explanations that accompany the definition have been changed with the intent of providing more clarity, and the amendments are intended to ensure that the definition of material is consistent across all IFRS. The changes take effect on Jan. 1, 2020, but early application is permitted.

SEC INVESTIGATIVE REPORT: PUBLIC COMPANIES SHOULD CONSIDER CYBER THREATS WHEN IMPLEMENTING INTERNAL ACCOUNTING CONTROLS On Oct. 16, 2018, the Securities and Exchange Commission issued an investigative report cautioning that public companies should consider cyber threats when implementing internal accounting controls. The report is based on the SEC Enforcement Division’s investigations of nine Winter 2018 | The Cooperative Accountant

ACCTFAX public companies that fell victim to cyber fraud, losing millions of dollars in the process.

The SEC’s investigations focused on “business email compromises” (BECs) in which perpetrators posed as company executives or vendors and used emails to dupe company personnel into sending large sums to bank accounts controlled by the perpetrators. The frauds in some instances lasted months and often were detected only after intervention by law enforcement or other third parties. Each of the companies lost at least $1 million, two lost more than $30 million, and one lost more than $45 million. In total, the nine companies wired nearly $100 million as a result of the frauds, most of which was unrecoverable. No charges were brought against the companies or their personnel.

The companies, which each had securities listed on a national stock exchange, covered a range of sectors including technology, machinery, real estate, energy, financial, and consumer goods.

Public issuers subject to the internal accounting controls requirements of Section 13(b)(2)(B) of the Securities Exchange Act of 1934 must calibrate their internal accounting controls to the current risk environment and assess and adjust policies and procedures accordingly. The FBI estimates fraud involving BECs has cost companies more than $5 billion since 2013.

“Cyber frauds are a pervasive, significant, and growing threat to all companies, including our public companies,” said SEC Chairman Jay Clayton. “Investors rely on our public issuers to put in place, monitor, and update internal accounting controls that appropriately address these threats.”

Stephanie Avakian, Co-Director of the SEC Enforcement Division, said, “In light of the facts and circumstances, we did not charge the nine companies we investigated, but our report emphasizes that all public companies have obligations to maintain sufficient internal accounting controls and should consider cyber threats when fulfilling those obligations.”

The issuance of the SEC’s report coincides with National Cybersecurity Awareness Month.

EFRAG PUBLISHES DRAFT COMMENT LETTER ON FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF EQUITY The European Financial Reporting Advisory Group Winter 2018 | The Cooperative Accountant

(EFRAG) has issued a draft comment letter on the IASB discussion paper DP/2018/1, ‘Financial Instruments with Characteristics of Equity’.

The IASB published its DP for comment on 28 June 2018. Final comments are due to the IASB

by January 17, 2019.

While EFRAG supports changes to IAS 32 Financial Instruments: Presentation, in its draft comment letter, EFRAG explains several “reservations” it has about the amendments proposed in the DP. These reservations include: ● the balance of costs and benefits of the information provided by the attribution approaches; ● separate presentation in the statement of financial position and statement of financial performance of derivatives, embedded derivatives and hybrids; ● accounting for standalone derivatives to extinguish an equity instrument consistently with a compound instrument; ● the proposed removal of the foreign currency rights issue exemption; classification changes for financial instruments that do not raise concerns in practice.

The draft comment letter also discusses new terminology introduced by the IASB’s DP: EFRAG acknowledges that a better articulation of IAS 32’s underlying principles could be an effective way to improve the consistency, clarity and completeness of the requirements and would require new terminology. However, new terminology would also require preparers and auditors to reconsider a wide range of past classification decisions. Accordingly, this approach, while addressing various interpretive issues, will also cause some disruption, create additional costs for preparers and risks the emergence of new issues and uncertainties.

The letter also asks that the IASB consider accounting for all standalone and embedded derivatives and derivative assets and liabilities under the scope of IFRS 9.

Comments on EFRAG’s draft comment letter are requested by December 3, 2018. For more information, see the press release and the draft comment letter on the EFRAG website. EFRAG has also released a four-minute video introducing the draft comment letter.

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TAXFAX

TAXFAX EDITOR George W. Benson McDermott Will & Emery LLP TAXFAX Guest Writers Daniel R. Schultz Cooperative Consulting, LLC

Limitations on Excess Losses from Farming Temporarily Replaced by Limitations on Excess Business Losses of Noncorporate Taxpayers

By George W. Benson The Tax Cuts and Jobs Act of 2017 (the “TCJA”) temporarily suspended Section 461(j), a special rule limiting the use of “excess farm losses” in the case of certain wealthy individuals, and temporarily replaced it with Section 461(l), a broader limitation on the excess business losses of all sorts (including farming losses) of certain noncorporate taxpayers.

The temporary suspension and replacement is for taxable years beginning after December 31, 2017 and before January 1, 2026.

Section 461(j) is a rather narrow provision targeting only large farming losses of wealthy individuals receiving farm subsidies. It was originally enacted as part of the Food, Conservation and Energy Act of 2008. The Senate Finance Committee Report (S. Rep. No. 110-206, 110 Cong., 1st Sess. 2007) stated: “The Committee believes that taxpayers receiving government assistance through payment programs and loan programs should not be allowed to claim unlimited amounts of losses from farming activities.” (at 76).

Section 461(j) limits the use of “excess farm losses” by certain taxpayers (other than C corporations) that receive any “applicable subsidy” for a year. For this purpose, “applicable subsidy” is defined as any direct or counter-cyclical payment under title I of the Food, Conservation, and Energy Act (or any payment elected to be received in lieu of any such payment) or any Commodity Credit 18

Christopher R. Duggan Dorsey & Whitney LLP

Corporation loan. “Excess Teresa H. Castanias, CPA farm losses” is defined as the excess of deductions for a year attributable to farming businesses over the sum of the aggregate gross income of the taxpayer for the year plus a “threshold amount.”

The threshold amount is the greater of (i) $300,000 ($150,000 in the case of married individuals filing separately) or (ii) the taxpayer’s total farming gross receipts for the prior five years over deductible farm expenses for the prior five years. Losses disallowed under Section 461(j) are treated as deductions of the taxpayer attributable to farming in the subsequent year.

Interestingly, Section 461(j) contains a broader than usual definition of farming. For persons engaged in farming with respect to a commodity, the definition sweeps in “any trade or business of the taxpayer of the processing of such commodity (without regard to whether the processing is incidental to the growing, raising, or harvesting of such commodity).” If the farmer is a member of a cooperative, any such trade or business of the cooperative “shall be treated as the trade or business of the taxpayer.” The Conference Committee Report (H.R. Conf. Rep. No. 110627, 110 Cong., 2d Sess. 2008) provided further explanation: “The farming activities of a cooperative are attributed to each member for purposes of this rule. Thus, a member of a cooperative who raises a commodity and sells it to the cooperative for processing is considered to Winter 2018 | The Cooperative Accountant

TAXFAX be the processor of such commodity. In this case, patronage dividends received from a cooperative that is engaged in a farming business are considered to be income from a farming business for purposes of this provision.” (at 1084).

New Section 461(l) is not limited to farming.

Nor is it limited to taxpayers that receive “applicable subsidies.” It limits the deduction of “excess businesses losses” of taxpayers other than C corporations carrying on any kinds of trades or businesses (including farming).

For purposes of Section 461(l), an “excess business loss” is the excess of (a) the aggregate deductions of the taxpayer for the year attributable to trades or businesses of such taxpayer, over (b) the sum of (i) the aggregate gross income or gain of the taxpayer for the taxable year from such trades or businesses plus (ii) $250,000 ($500,000 in the case of a married couple filing a joint return), adjusted for inflation. There is no adjustment for profits earned in prior years as there is in Section 461(j) and no limitation on its applicability to taxpayers receiving “applicable subsidies.”

Excess losses are treated as net operating loss carryovers under Section 172. As a consequence, the new 80% limitation on the use of net operating loss carryover deductions applies. Section 461(l) (2) specifically provides that the disallowed losses “shall be treated as a net operating loss carryover to the following taxable year under section 172.”

This is in contrast with Section 461(j) which provides that excess farm losses disallowed under Section 461(j) are treated as deductions “of the taxpayer attributable to farming businesses in the next taxable year,” not as Section 172 net operating loss carryovers. Does the language of Section 461(j) override the special two-year carryback rule that continues in Section 172(b)(1)(B) for farming losses?

Taxpayers with farming businesses that historically were not subject to Section 461(j) may find themselves subject to Section 461(l).

The limitations in both sections are in addition to all other limitations upon the use of losses contained in the Code. The Code specifies that Section 461(j) is applied before the application of Section 469 (the passive loss rules). For new Section 461(l), the Code specifies that it applies after the application of Section 469.

The IRS has never gotten around to promulgating regulations under Section 461(j). The Conference Report does contain several examples of its intended application.

Like most provisions in the TCJA, new Section 461(j) presents a variety of questions as to how Winter 2018 | The Cooperative Accountant

it works and how it relates to other provisions in the Code. The IRS has announced that there is a project underway to write regulations for Section 461(l).

New Tax Act Makes Changes to the Section 451 Income Recognition Rules

By Dan Schultz The new Tax Cuts and Jobs Act (TCJA) enacted on December 22, 2017 made significant revisions to the rules under Section 451 that determine the tax year in which income is recognized by accrual basis taxpayers. Section 451 was restructured to include the new recognition rules as Sections 451(b) and 451(c).

Background – pre-TCJA rules The general rule for determining when accrual method taxpayers must recognize and include items of income in taxable income is known as the “all-events test.” The all-events test provides that under an accrual method of accounting, income is includible in gross income when all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy.

The all-events test, as applied in practice, is stated as: “All the events that fix the right to receive income occur when (1) the income is earned, i.e., the required performance takes place, (2) payment is due, or (3) payment is made, whichever happens first.” Thus, accrual basis taxpayers who earned an item of income by providing the required goods or performing the required services in a tax year preceding the tax year in which payment was due under the contract, or payment was received in cash or cash equivalents, were required to recognize and pay tax on the income in the earlier tax year in which it was earned, but prior to receiving payment in cash.

In the opposite situation, where advance payments were received or due and payable under the terms of the contract in a tax year or years preceding the tax year in which the item of income was earned, accrual basis taxpayers were required under the all-events test to recognize the advance payments as taxable income in a tax year prior to the year in which the income was actually earned. Because this could result in a significant mismatch in the timing of the taxpayer’s recognition of income versus the tax deductions for expenses incurred in earning such income, the IRS provided an elective deferral method of accounting for advance payments for goods, services, and other specified items, which is currently set forth in Revenue Procedure 2004-34. The safe harbor of Revenue Procedure 2004-34 allows taxpayers 19

TAXFAX a one-year deferral of advance payments to the extent not earned in the year of receipt.

TCJA Revisions Act Section 13221(a) adds new Section 451(b), titled “Inclusion not later than for financial accounting purposes,” which codifies the allevents test but adds a fourth component to the test by requiring that an item of income must be recognized no later than the tax year in which the item is taken into account as revenue in an applicable financial statement. Section 451(b) also provides that in the case of a contract with multiple performance obligations, the taxpayer can allocate the transaction price in accordance with the allocation made in the taxpayer’s applicable financial statement.

Act Section 13221(b) adds new Section 451(c), “Treatment of advance payments,” which codifies the deferral method of accounting provided for in Revenue Procedure 2004-34, for advance payments for goods, services and other specified items.

New Section 451(c) thus allows accrual method taxpayers to elect to defer the inclusion of income associated with certain advance payments until the end of the tax year following the tax year of receipt, as long as the revenue is also deferred for financial statement purposes. In the case of advance payments received for a combination of services, goods, or other specified items, the new provision allows the taxpayer to allocate the transaction price in accordance with the allocation made in the taxpayer’s applicable financial statement.

The application of the new rules is a change in method of accounting for purposes of Section 481. The new rules generally apply to tax years beginning after December 31, 2017.

Observation: With some exceptions, the new financial statement conformity requirement is not intended to prevent the use of special methods of accounting provided elsewhere in the Code, e.g., the installment method under Section 453 or longterm contract methods under Section 460 can still be used. The IRS has announced that it intends to issue proposed regulations providing that accrued market discount is not covered by the new rules.

Notice 2018-80 (September 27, 2018).

Observation: The new provisions do not revise the rules for determining when an item of income is realized (as opposed to recognized) for Federal income tax purposes. Thus, recognition of income is not required in situations where the Federal income tax realization event has not yet occurred.

For example, the new rules do not require the recharacterization of a transaction from a sale to a lease, or vice versa, to conform to how the 20

transaction is reported in the applicable financial statement.

The IRS and Treasury are currently in the process of issuing guidance for the implementation of these new rules, including the procedures for any required accounting method changes.

Pending issuance of guidance under Section 451(c), the IRS has announced that “taxpayers may continue to rely on Rev. Proc. 2004-34 for the treatment of advance payments.” Notice 2018-35 (April 12, 2018). In addition, the IRS has issued a notice that it proposes to remove Treas. Reg. § 1.451-5, an alternative set of rules that some taxpayers used to defer advance payments. In the notice the IRS stated that “[n]ew section 451(c) and its election to defer advance payments override the deterral method provided by § 1.451-5.” See REG104872-18 (October 15, 2018).

Caveat: The scope of this article is limited to providing an overview of the revisions made to Section 451 by the new TCJA, and to serve as an orientation to these new rules.

Adding financial statement conformity to the allevents test adds a new level of complexity to both tax compliance and financial accounting for income taxes. There are also a number of exceptions in the new rules involving various types of income to become aware of and consider. We can only hope the IRS will be able to provide timely guidance to ease the transition.

Country Club Denied Deduction for Loss Generated by a Consistently Unprofitable Nonmember Activity

By George W. Benson The Tax Cuts and Jobs Act of 2017 (the “TCJA”) contains one provision that promises to be particularly troublesome for organizations that are tax exempt under one of the subsections of Section 501(c).

Tax exempt organizations are taxed on their unrelated business income. Historically, tax exempt organizations with income from some unrelated activities and losses from others were allowed to offset the income and losses. They were taxed only on net unrelated business income.

This has now changed. New Section 512(a)(6) prohibits such netting. The Conference Committee Report that accompanied the TCJA states: “The result of the provision is that a deduction from one trade or business for a taxable year may not be used to offset income from a different unrelated trade or business for the same year. The provision generally does not, however, prevent an organization from using a deduction from Winter 2018 | The Cooperative Accountant

TAXFAX one taxable year to offset income from the same unrelated trade or business activity in another taxable year, where appropriate.”

A recent decision of the Sixth Circuit Court of Appeals illustrates why this change was made.

Losantiville County Club (the “Club”), a county club exempt under Section 501(c)(7) that includes an 18-hole golf course, a swimming pool, tennis courts, dining facilities and meeting and reception rooms, for many years hosted nonmember events “to generate additional revenue and attract new members.” The Club’s nonmember events consistently resulted in net losses. While gross revenue significantly exceeded direct expenses, it did not exceed direct expenses and an allocable share of indirect expenses. In fact, the Club lost money on nonmember events every year from 2002 through 2015.

The indirect expenses allocated to nonmember events included a portion of salaries and wages, employee benefits, repairs, depreciation, grounds maintenance, supplies, and general and administrative expenses. Expenses were allocated using a “gross-to-gross allocation method” – the Club used the “ratio of nonmember sales to total sales to determine what portion of indirect expenses was attributable to nonmember sales.”

On its tax return, the Club netted the losses against otherwise taxable investment income (which for clubs exempt under Section 501(c)(7) is treated as unrelated business income). This totally eliminated the Club’s unrelated business income for the years at issue.

In an audit of the Club’s 2010, 2011 and 2012 tax returns, the IRS asserted that the Club did not intend to profit from the nonmember activities and thus was not entitled to deduct the losses as trade or business expenses under Section 162. The IRS concluded that the Club owed tax on its investment income. It also asserted the 20% accuracy-related penalty.

The Tax Court sided with the IRS. Losantiville Country Club v. Commissioner, 114 TCM 198 (2017). The Club appealed. The Sixth Circuit affirmed the conclusions of the Tax Court, though it corrected some of the Tax Court’s reasoning.

Losantiville Country Club v. United States, No. 172394 (6th Cir. 2018).

The Sixth Circuit opinion focuses on whether the Club had a profit motive for the nonmember activities. It was certainly economically rational for the Club to carry on the activities, even though they resulted in losses, so long as the activities generated revenue in excess of direct expenses, which they did consistently from 2002-2015. The nonmember activities helped the Club partially recover overhead costs that would otherwise have Winter 2018 | The Cooperative Accountant

had to be recovered from members through higher dues and charges.

However, this was not enough for the activity to rise to the level of a trade or business. The Club needed to establish that it intended to earn a profit. The Sixth Circuit observed that, where a taxpayer has consistently incurred losses in an activity, a heavy burden is placed on the taxpayer to demonstrate a profit motive. The Sixth Circuit concluded that the Club “never adduced any evidence that it attempted to stem its flood of losses, or that it expected to eventually profit.”

The Sixth Circuit then proceeded to affirm the imposition of accuracy-related penalties, rejecting the Club’s argument that it relied on a tax professional (“The record reflects that Losantiville conveyed its own opinions about the club’s tax obligations to its accountants, not that the accountants ever evaluated Losantiville’s position.”) and its argument of legal justification (“in contrast, Losantiville marshalled virtually no evidence supporting its arguments for underpayment even under its argument for a novel application of Portland Golf Club.”).

The IRS has begun the rule making process for new Section 512(a)(6). See, Notice 2018-67 (August 21, 2018), setting forth some interim guidance and transition rules and soliciting comments.

One portion of the regulations might have relevance for cooperatives. Notice 2018-67 states that regulations will contain guidance as to how expenses should be allocated between an exempt organization’s exempt function and its various trades or businesses subject to the unrelated business tax. In particular, the IRS is concerned with “dual use facilities,” i.e., facilities used in two or more trades or businesses or in the exempt function and one or more trade or business.

“The Treasury Department and the IRS currently have an item on the Priority Guidance Plan regarding methods of allocating expenses relating to dual use facilities. The allocation issues under § 512(a)(1) [between exempt functions and unrelated business activities] are also relevant under § 512(a)(6) because an exempt organization with more than one unrelated trade or business must not only allocate indirect expenses among exempt and taxable activities as described in § 1.512(a)1(c) and (d) but also among separate unrelated trades or businesses. The Treasury Department and the IRS therefore are considering modifying the underlying reasonable allocation method in § 1.512(a)-1(c) and providing specific standards for allocating expenses relating to dual use facilities and the rules under § 512(a)(6).”

(Section 3.04).

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TAXFAX It is not clear how the new rules will apply to social clubs like the Club. Notice 2018-67 states that “a social club’s nonmember income is treated as gross income from an unrelated trade or business under § 512(a)(3)” (which appears to be a departure from what the IRS argued in Losantiville). The Notice then observes “a social club that receives nonmember income from multiple sources, such as from a dining facility and from a retail store, would have more than one unrelated trade or business and therefore be subject to the requirement of § 512(a)(6).” But can a social club still net nonmember losses (assuming the trade or business test is met) against investment income? This is not completely clear since Section 512(a)(6), as written, applies just to netting between separate trades or businesses. Having said that, the IRS will likely be tempted to try to classify investment income as income from a trade or business for this purpose.

The Notice requests “comments regarding how these exempt organizations’ investment income should be treated for purposes of § 512(a)(6).”

See, Section 7.

Relevance for cooperatives.

It would be a stretch for the IRS to attempt to use Losantiville to characterize nonmember/ nonpatronage activities of most cooperatives as not amounting to a trade or business.

Subchapter T cooperatives (including socalled “exempt” Section 521 cooperatives) are not subject to the unrelated business income tax and thus are not covered by Section 512(a)(6). So upcoming regulations under that section will not be directly applicable to cooperatives. However, that does not mean that advisors to cooperatives can simply ignore developments in this area.

For instance, many cooperatives have dual use facilities, i.e., facilities used in both patronage and nonmember/nonpatronage activities. There is little guidance as to how expenses related to such facilities should be allocated by cooperatives.

What future regulations promulgated under Section 512(a)(6) may provide with respect to dual use facilities may provide a reference point for judging the reasonableness of a cooperative’s treatment of expenses related to dual use facilities.

Interim Guidance on the Treatment of Meals Provided in Conjunction with Entertainment

By George W. Benson The Fall, 2018 TAXFAX Column included an article describing the changes made by the Tax Cuts and Jobs Act of 2017 (the “TCJA”) to the tax treatment of meals and entertainment. That article indicated that many grey areas were created by the TCJA, including when a meal might be considered 22

entertainment.

In early October, the IRS released Notice 201876 announcing that the Treasury and the IRS intend to issue proposed regulations under Section 274 “which will include guidance on the deductibility of expenses for certain business meals.” The Notice went on to provide that until the proposed regulations are final, a taxpayer “may deduct 50 percent of an otherwise allowable business meal expense if: 1. The expense is an ordinary and necessary expense under § 162(a) paid or incurred during the taxable year in carrying on any trade or business; 2. The expense is not lavish or extravagant under the circumstances; 3. The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages; 4. The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and 5. In the case of food and beverages provided during or at an entertainment activity, the food and beverages are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices, or receipts. The entertainment disallowance rule may not be circumvented through inflating the amount charged for food and beverages.

The Notice contains an example of a taxpayer who invites a business contact to a baseball game and buys tickets, hot dogs and drinks. The tickets are nondeductible entertainment expenses, but 50% of the cost of the hot dogs and drinks may be deducted as a meals expense. The Notice contains two other examples involving attendance at a basketball game. In one, the cost of tickets for a suite include food and beverages. Because the cost of the food and beverages is not separately stated on the invoice for the suite tickets, the entire expense is a nondeductible entertainment expense. In the other, the cost of food and beverages is separately stated on the invoice for the suite tickets. As a consequence, 50% of the cost of food and beverages can be deducted as a meals expense.

IRS Rules that Multi-Stakeholder Cooperative with Nonproducer Member Class Does Not Qualify as Section 521 Tax-Exempt Farmers’ Cooperative

By Christopher R. Duggan In PLR 201835010 (Aug. 31, 2018), the IRS held that Winter 2018 | The Cooperative Accountant

TAXFAX a cooperative that facilitated sales of farm products between producers and consumers failed to qualify as a tax-exempt farmers’ cooperative under Section 521 of the Code. The ruling signifies that no cooperative that includes nonproducer memberpatrons qualifies as a farmers’ cooperative under Code Section 521.

The cooperative’s articles of incorporation state that it was formed for various lofty purposes, such as creating a cooperative “rooted in local food production” which “strengthens the physical and financial wellbeing of the community” and “empower[ing] the community to educate itself.”

The most substantive purpose is “to provide local food producers and consumers a year-round market for buying and selling goods and services according to consumer cooperative and financially sound principles.”

The cooperative pursued these purposes by operating an on-line marketplace – a “local food hub” – that advertised products offered by local producer members. Consumer members could order these products through the cooperative’s Internet site but the actual exchange transaction took place between the consumer and producer at a specified location. The products not only included such items as fruits, vegetables, fish and honey, but also processed or imported items such as tea, chocolate and ice cream.

The ruling states that the cooperative “function[ed] like a food co-op” and the majority of its members were consumers rather than producers.

The cooperative’s income apparently arose solely from an annual membership fee collected from members. The ruling does not indicate that the membership fee differed for consumer versus producer members, though producer members undoubtedly received more economic benefits than consumer members from the cooperative.

The provisions on cooperative operation in the cooperative’s governing documents appear to have been drafted by a non-specialist in cooperative tax law. The governing documents provide that the cooperative shall operate “as nearly as possible at cost” for the mutual benefit of its members, provided that the Board of Directors in its discretion may set aside and accumulate reasonable reserves.

If amounts in excess of reasonable reserves are received, such amounts “shall be accumulated in a surplus fund.” Some or all of the surplus fund “shall be distributed to members as determined by the Board.” Such distributions would be unlikely to qualify as valid patronage dividends under Subchapter T because of lack of a pre-existing obligation.

The cooperative’s income statement, moreover, appears to have been created by a non-accountant.

The ruling states that the income statement Winter 2018 | The Cooperative Accountant

“includes sales which is offset by cost of goods sold,” a puzzling sentence because producers made product sales, not the cooperative.

The cooperative appears to have been intended as a multi-stakeholder cooperative with a consumer member class and a producer member class. The cooperative was not carefully organized, however, and lacked standard patronage refund and consent provisions and any methodology for dividing cooperative income between the producer and consumer classes.

The ruling rightly holds that the cooperative failed to qualify as a Section 521 cooperative. The fundamental problem, in the IRS’ view, was that the cooperative included nonproducer members, though the ruling fails to explain precisely why a Section 521 cooperative with producer members cannot create a consumer member class to share in net income. The obstacle, I believe, is that Section 521 requires a cooperative to market the products of and/or supply equipment to farmerproducers “at cost” after deducting “necessary expenses,” which precludes any diversion of income to nonproducer members. Code § 521(b) (1); Treas. Reg. § 1.521(a)(1) and (b). The ruling also holds that the cooperative’s mere facilitation of sale exchanges, without acting as middleman, failed to satisfy Section 521 requirements, which it appears to hold require physical participation in marketing for or selling supplies and equipment to producers.

The ruling does not explain why Internet advertising of producer products fails to qualify as “marketing” under Code Section 521, although the language of Section 521 implies that a Section 521 cooperative must actually sell producer products in order to “turn[] back the proceeds of sales” less necessary expenses to the producers.

In short, the ruling discourages attempts by cooperatives that distribute any income to nonproducer members to qualify under Section 521.

Modified Net Operating Loss Deduction under TCJA

By Teree Castanias The Tax Cuts and Jobs Act of 2017 (TCJA) limits the net operating loss (NOL) deduction for a given tax year to 80% of taxable income, effective with respect to losses arising in tax years beginning after December 31, 2017. This limitation is similar to the 90% limitation for NOLs that was in the corporate alternative minimum tax (AMT) regime. The corporate AMT was repealed in the new tax law.

The new law requires corporations to track NOLs arising in tax years beginning (1) on or before December 31, 2017, and (2) after December 31, 2017, separately as only the latter category of NOLs is subject to the 80% limitation.

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TAXFAX How this limitation will be applied when a applies to losses arising in tax years beginning taxpayer has both types of NOLs is not completely December 31, 2017 whereas the statutory

By Barbaraafter A. Wech clear. The issue is when is the 80% limitation language regarding the indefinite carryover and computed for purposes of applying the limitation the elimination (for most taxpayers) of the NOL to a particular tax year. Assume a calendar year carryback applies to losses arising in tax years taxpayer with $90 of NOLs carried over from its ending after December 31, 2017. So, under the 2017 year (not 80% limited) and $10 of NOLs statutory language, the NOLs of a fiscal year carried over from its 2018 year (80% limited), taxpayer arising in a tax year that begins before and $100 of taxable income in its 2019 year.

December 31, 2017 and ends after December 31, One approach is that the taxpayer can use all of 2017 are not subject to the 80% limitation but (for the NOL carryovers because under the revised most taxpayers) may not be carried back and may Section 172(a), the limitation for 2019 would be be carried forward indefinitely. However, both the $10, which is the lesser of (a) the NOL carryover Conference Report’s explanatory statement and subject to the 80% limitation ($10) and (b) 80% of the Joint Committee on Taxation’s revenue table the taxable income computed without regard to indicate that the provision applies to losses arising the NOL deduction ($80). It can also be argued in tax years beginning after December 31, 2017. It that the taxpayer cannot use any of the $10 NOL appears that technical correction to the law will be from 2018 because the aggregate NOL carryover necessary to fix this issue. deduction is limited to 80% of taxable income (again, computed without regard to the NOL Tax planning opportunities deduction) or $80. Under this interpretation, the Taxpayers may want to consider the interaction available NOLs are absorbed chronologically, so of the 80% limitation on their tax position and the 2017 NOL is absorbed but none of the 2018 consider other tax strategies to mitigate the NOL is used. Further guidance from the IRS will loss of the full NOL deduction. The increased be needed to determine which approach will be expensing allowances provided under TCJA allowed. may be considered for this. Taxpayers may find The new tax law also repeals the pre-enactment it beneficial to stagger purchases as long as full carryback provisions for NOLs. The statutory expensing is available, or selectively elect out language indicates that this provision applies to of full expensing for property in one or more NOLs arising in tax years ending after December depreciation recovery classes during this period if 31, 2017, although it permits a new two-year doing so would avoid creating or increasing NOLs carryback for certain farming losses and retains subject to the 80% limitation. pre-enactment law for NOLs of property and Cooperatives will particularly want to consider casualty insurance companies. Certain carryback the 80% limitation in their planning as the provisions applied under pre-enactment law patronage dividend deduction may create a tax for specific categories of losses (e.g. “specified loss on the tax return if the cooperative is using liability losses” may be carried back 10 years). the “book” or “modified book” basis for paying its The repeal of the carryback provisions includes patronage dividend. the repeal of carryback limitations applicable to The 80% limitation on post-2017 NOLs and corporate equity reduction transactions (CERTs). the elimination of post-2017 NOL carrybacks CERTs were used by corporations to finance combined with the reduction of the corporate leveraged acquisitions or distributions with tax tax rate provide corporations with a significant refunds generated by the carryback of the interest incentive to accelerate deductions into 2017 and deductions resulting from the added leverage. to defer income into 2018.

Certain limitations will apply to these transactions The changes to the NOL carryover provisions in carrying back NOLs. may have an impact on the financial statement The new tax law provides for the indefinite treatment of loss carryovers incurred in future tax carryforward on NOLs arising in tax years ending years, given that unused loss carryovers no longer after December 31, 2017. This replaces the 20expire. year carryforward under old law.

Treasury and the IRS National Office continue As with many other areas of the new tax law, to work on providing guidance on the TCJA law. drafting errors in the law have caused issues Taxpayers and practitioners are encouraged to visit for fiscal year taxpayers. The 80% limitation the IRS website for information.

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Winter 2018 | The Cooperative Accountant

TAXFAX

Abstract This article introduces the concept of a learning organization or culture. It also identifies why such a culture is important by identifying various benefits seen by organizations that have implemented a learning environment. Two approaches to implementing learning cultures are described along with the assessment tools associated with each one. Either or both approaches and tools will allow a manager the opportunity to assess their department’s or organization’s current standing in terms of where they are as a learning culture and where they can improve.

What is a Learning Organization or Learning Culture?

According to Gavin, Edmonson, and Gino (2008), a learning organization or culture is one in which its employees create, acquire, and transfer knowledge in order to assist their company to adapt more quickly than their competition. Why would an organization want to create a learning culture? Many benefits have been identified with a strong learning culture (Blackwood, 2014).

Winter 2018 | The Cooperative Accountant

Small Business Coop Forum Editor Barbara A. Wech Department of Management, Information Systems, and Quantitative Methods University of Alabama at Birmingham Collat School of Business CSB 364 bawech@uab.edu

These benefits include, but are not limited to, gains in efficiency, productivity, job satisfaction, organizational commitment, the ability to deal with change, and increased profits. Such organizations have experienced decreased turnover, as well.

Why? If your company does not have a focus on a learning organization, should your accounting department consider creating and maintaining a 25

SMALL BUSINESS COOPERATIVE FORUM learning culture? Evidence suggests the answer is you with a couple examples of how to implement learning culture in your area.

“Yes.” Thomson Reuters (2017) published a white A.a Wech

By Barbara paper which identified reasons why accounting firms (and consequently accounting departments) How to Implement a Learning Culture There are numerous ways to go about should be interested in implementing a learning establishing and reinforcing a culture of culture. One reason has to do with attraction learning. I have selected two approaches to and maintenance of new accounting talent. We introduce to you. These are straightforward know that as the economy improves and there and offer assessment tools that allow for actual are more opportunities, it is a good situation for people looking for jobs which is leading to a high implementation. Sarder (2016) has identified amount of turnover of accountants (AICPA Private that learning cultures have four characteristics: the right leaders, the right people, the right Company Practice Section, 2015). With the job behaviors, and the right resources. He also market as challenging and tight as it is for hiring offers a set of questions to help you establish companies, instituting a learning culture can be where you are and where you need to go on your seen as a competitive advantage over others. learning culture journey. The second approach, Another reason to focus attention on a developed by Garvin et al. (2008), has identified learning culture has to do with Millennials. This three building blocks on which to build a generation, born between 1980 and 1996, learning culture. Out of their research, they have expects that the organizations they go to work developed an assessment tool to evaluate how for will be providing professional development well you are doing in each of the three building opportunities. Having opportunities to learn blocks. and develop is one of the highest priorities of this group in searching for a job and remaining Sarder’s Framework for Building a Learning with an employer (Gallup, 2016). If potential Culture employees do not see that their hiring As already noted, Sarder (2016) has identified four organization and department value education characteristics of a learning culture. They include and development, they may view that employer having the right leader, the right people, the right not interested in investing in the futures of their behaviors, and the right resources. Let’s look at employees and decide to look elsewhere. each of the four in more detail.

That brings us to another reason for instituting Most everyone agrees that a learning culture a learning culture: developing employees to be starts at the top. At the organization level, this future leaders in the accounting function and would be the CEO. At the department level, this the organization. With the tight labor market, would be the department manager, etc. It is it is more beneficial to train employees in areas crucial that this individual supports learning and where they have gaps than to go out and try and is a learner. The right leader values learning and hire a new employee. In most organizations, communicates that to employees. He or she can even if the labor market is conducive to hiring explain why learning is important to achieving new employees, many will not want to spend the goals and objectives of the organization and the money to add additional employees. Also, of the individual employee. The right leader is training current employees makes sense because also a role model for learning. In other words, the you are familiar with the employees and their right leader walks the talk. The leader provides performance and future abilities. A learning culture helps bolster succession plans and training learning opportunities and rewards those who take advantage of the opportunities. people to get them where you need them to be The leader cannot create and maintain a in the future. learning culture alone. Other employees are With increased competition, continual needed to support the learning environment. advances in technology, and changing customer The right leader seeks out these right employees expectations, creating a learning culture is within the organization. The leader also makes crucial (Garvin et al., 2008). So why haven’t more sure when hiring that employees are selected who companies done it? They do not know how to do not only are qualified for the job that is open, but it. The remaining part of this article will provide 26

Winter 2018 | The Cooperative Accountant

SMALL BUSINESS COOPERATIVE FORUM who seek to learn more in order to advance and improve. The right people do not fear change but rather see it as an opportunity. The right people look at mistakes and difficult problems as learning prospects.

The right behaviors from leaders and employees are important for a learning culture.

Sarder (2016) identifies four behaviors as indicative of a learning culture: collaboration, innovation, experimentation, risk taking, and information sharing. Employees who are learning share information and debate the correct solutions. To enable a learning environment, management must support a safe environment: one where people are not punished or humiliated when mistakes are made. Mistakes should be viewed as a part of the learning process.

Employee inputs are valued even if the inputs are criticisms. All managers at all levels should display the behaviors of the right leader: fostering learning and being learners themselves. Policies and procedures should be reviewed and modified if they do not support the sharing of information, collaboration, etc. Barriers to learning should be removed and that is an important role of managers at all levels. Physical spaces should promote communication and collaboration. Even if people have separate offices, a shared, open space should exist for collaboration.

The right resources should be committed to support the learning culture. As accountants, you know one resource involved here is money. Money must be committed to support learning where it is necessary, such as for training. Time away from work is another resource. Employees may need time away for training or for collaboration on problem-solving.

In order to help managers create and implement a learning culture, Sarder (2016) has identified 30 questions to be addressed. Once the questions are answered, they can help you identify where you are at in terms of a learning culture and where you need to make changes. Not all questions may be pertinent to your situation, so you may need to select what applies to your organization or department. The response set to the questions would be as follows: ● Yes, to a great extent ● Seldom, if ever ● To some degree ● Don’t know Winter 2018 | The Cooperative Accountant

1. Do we continuously ask ourselves what’s working, what’s not, and what we can do to get better?

2. Do our managers and leaders acknowledge mistakes and ask for help when they need it?

3. Do we encourage employees to speak their minds and ask questions about – and perhaps to challenge – our decisions?

4. Do our managers see themselves as coaches, mentors, and facilitators whose most important job is to help employees do their best work?

5. Do people at all levels listen to and respect one another’s ideas, concerns, and points of view even if they disagree?

6. Does everyone in this organization continuously look for ways to improve our products, services, processes, policies, and procedures?

7. Do our employees feel safe enough to take risks, experiment with new ways of doing things, and make the mistakes that are an essential part of the learning process?

8. Do managers, teams, and individuals at all levels openly share information and have ready access to the information they need?

9. Have we eliminated policies, procedures, and structures that create unnecessary bureaucracy?

10. Do we value learning enough to include learning and development as an essential budget item even when times are tough?

11. Are our employees engaged in their work?

12. Do people seek ways to help one another succeed?

13. Are we able to attract and retain the employees we want?

14. Do our human resources and compensation policies reward people for learning and for helping others learn?

15. Do managers give people the time they need to learn, reflect on their learning, and apply what they learn on the job?

16. Do we offer a variety of learning options to meet a diversity of learning needs and styles?

17. Do we ensure that learning goals, initiatives, programs, and activities are clearly aligned with our mission, values, strategic goals, and business needs?

18. Do our senior leaders serve as role models by 27

SMALL BUSINESS COOPERATIVE FORUM being learners themselves?

19. Do our employees understand the value of learning to their own and the organization’s success?

20. Do we use technology such as social media and electronic bulletin boards to help people learn and share what they learn?

21. Do we learn from and share our learning with our customers, vendors, and others outside the organization?

22. Do our senior managers seek input from others both inside and outside the organization before making important decisions and then clearly explain the reasons for those decisions?

23. Do we learn from other organizations’ best practices?

24. Are we willing to change even longestablished practices when something isn’t working or we discover a better way to accomplish our goals?

25. Do our employees generally see problems as learning opportunities?

26. Do people at every level give credit where credit is due?

27. Does the design of our workplaces encourage people to communicate with one another?

28. Do managers help employees set development goals as well as performance goals?

29. Do we have an effective system for managing our learning operation so that things run smoothly and efficiently?

30. Do we assess our learning programs regularly to see how well they are working and make necessary changes?

Garvin, Edmondson, and Gino’s Building Blocks of a Learning Organization Garvin et al. (2008) identified three building blocks to a learning organization. As noted earlier, if your organization is not involved in the effort, focus your attention on your department. The building blocks apply there, as well. Their three building blocks are: a supportive learning environment, concrete learning processes, and leadership that reinforces learning. Let us look at each one in turn.

A supportive learning environment has 4 characteristics. The first characteristic is psychological safety. Similar to Sarder (2016), 28

employees must feel safe to make mistakes, ask questions, disagree, etc. without fearing punishment, belittling, or other negative retaliatory behaviors. The next characteristic is the appreciation of differences. We learn by assessing and debating opposing ideas. The third characteristic is openness to new ideas. This involves risk taking and exploring the unknown.

Lastly, we have time for reflection. Learning environments allow time for reflection about what the department is doing. As most of us know, working to deadlines and putting out day-to-day fires does not allow much time for thoughtful reflection and learning to take place.

The second building block is concrete learning processes and practices. A department or company has formal processes for generating, collecting, interpreting, and disseminating information and knowledge. This can include information gathered to keep track of competitor and technology trends, problem-solving analysis and interpretation, and education and training for employee development. In other words, learning is not chaos or hit-or-miss; it is a process in and of itself.

The final building block is leadership that reinforces learning. Again, like Sarder (2016), there is a focus on the importance of leadership supporting the learning culture. Organizational or department leaders model an interest in alternative viewpoints, communicate and support the importance of spending time on problem solving, knowledge transfer, and reflection on learning, and management actively questions and actively listens to their employees.

Garvin et al. (2008) have developed an assessment to help managers assess the learning culture in their organizations. The assessment measures each building block and its subcomponents separately allowing for detailed information to be gained regarding the current status of your learning culture. It will allow for identification of what you are doing well and where you can improve. The questionnaire is included below, but the assessment can be taken online (https://hbs.qualtrics.com/jfe/form/SV_ b7rYZGRxuMEyHRz?Q_JFE=qdg).

Garvin et al. Learning Organization Survey BUILDING BLOCK 1 Supportive Learning Environment Psychological Safety Winter 2018 | The Cooperative Accountant

SMALL BUSINESS COOPERATIVE FORUM In this unit, it is easy to speak up about what is on your mind.

If you make a mistake in this unit, it is often held against you.

People in this unit are usually comfortable talking about problems and disagreements.

product or service offerings.

This unit has a formal process for conducting and evaluating experiments or new ideas.

This unit frequently employs prototypes or simulations when trying out new ideas.

Information Collection

People in this unit are eager to share information about what does and doesn’t work.

This unit systematically collects information on competitors.

Keeping your cards close to your vest is the best way to get ahead in this unit.

This unit systematically collects information on economic and social trends.

Appreciation of Differences Differences in opinion are welcome in this unit.

This unit systematically collects information on customers.

Unless an opinion is consistent with what most people in this unit believe, it won’t be valued.

This unit systematically collects information on technological trends.

This unit tends to handle differences of opinion privately or off-line, rather than addressing them directly with the group.

This unit frequently compares its performance with that of competitors.

In this unit, people are open to alternative ways of getting work done.

Openness to New Ideas

This unit frequently compares its performance with that of best-in-class organizations.

Analysis

In this unit, people value new ideas.

This unit engages in productive conflict and debate during discussions.

Unless an idea has been around for a long time, no one in this unit wants to hear it.

This unit seeks out dissenting views during discussions.

In this unit, people are interested in better ways of doing things.

This unit never revisits well-established perspectives during discussions.

In this unit, people often resist untried approaches.

This unit frequently identifies and discusses underlying assumptions that might affect key decisions.

Time for Reflection People in this unit are overly stressed.

Despite the workload, people in this unit find time to review how the work is going.

This unit never pays attention to different views during discussions.

Education and Training

In this unit, schedule pressure gets in the way of doing a good job.

Newly hired employees in this unit receive adequate training.

In this unit, people are too busy to invest time in improvement.

Experienced employees in this unit receive periodic training and training updates.

There is simply no time for reflection in this unit.

Experienced employees in this unit receive training when switching to a new position.

BUILDING BLOCK 2 Concrete Learning Processes and Practices Experimentation This unit experiments frequently with new ways of working.

This unit experiments frequently with new Winter 2018 | The Cooperative Accountant

Experienced employees in this unit receive training when new initiatives are launched.

In this unit, training is valued.

In this unit, time is made available for education and training activities.

Information Transfer 29

SMALL BUSINESS COOPERATIVE FORUM This unit has forums for meeting with and learning from experts from other departments, teams, or divisions.

This unit has forums for meeting with and learning from experts from outside the organization.

This unit has forums for meeting with and learning from customers and clients.

This unit has forums for meeting with and learning from suppliers.

This unit regularly shares information with networks of experts within the organization.

This unit regularly shares information with networks of experts outside the organization.

This unit quickly and accurately communicates new knowledge to key decision makers.

This unit regularly conducts post-audits and after-action reviews.

BUILDING BLOCK 3 Leadership That Reinforces Learning My managers invite input from others in discussions.

My managers acknowledge their own limitations with respect to knowledge, information, or expertise.

My managers ask probing questions.

My managers listen attentively.

My managers encourage multiple points of view.

My managers provide time, resources, and venues for identifying problems and organizational challenges.

My managers provide time, resources, and venues for reflecting and improving on past performance.

the workplace. Both have assessment tools that can help you identify where your department or organization is on the learning culture spectrum and where you can improve. I strongly suggest you do the assessments. Even more so, I encourage you to have others in your department take the assessment, as well. Should you decide to implement a learning culture, you will not be able to do it alone. You will need the help and support of your employees. Get them involved and one simple way to do it from the start is to have them participate and provide feedback in the assessment process.

References AICPA Private Company Practice Section (PCPS).

(2015, June 9). AICPA Survey: Recruiting and Retaining Staff Emerge as Top Concerns for Most CPA Firms [Press release]. Retrieved from http:// www.aicpa.org/PRESS/PRESSRELEASES/2015/ Pages/AICPA-Survey-Recruiting-andRetainingStaff-Emerge-as-Top-Concerns-for-Most-CPAFirms.aspx Blackwood, K. (2014). Benefits of creating an organizational learning culture. Business Vancouver. Retrieved from https://www. biv.com/article/2014/9/benefits-creatingorganizationallearning-culture/.

Gallup (2016). How Millennials want to work and live. Washington D. C.: Gallup.

Garvin, D. A., Edmondson, A. C., & Gino, F. (2008). Is yours a learning organization? Harvard Business Review, 86(3), 109-116.

Sarder, R. (2016). Building an innovative learning organization: A framework to build a smarter workforce, adapt to change, and drive growth.

Hoboken, New Jersey: John Wiley & Sons, Inc. Thomson Reuters (2017). Creating a learning vision for your firm. Toronto, Canada: Thomson Reuters.

My managers criticize views different from their own point of view.

Conclusion I have introduced you to the learning organization or the learning culture. It is clear that such an environment is important for many reasons including improved productivity and profits as well as increased employee attraction and retention, to name a few. I have identified two approaches to learning cultures that can be implemented in 30

Winter 2018 | The Cooperative Accountant

SMALL BUSINESS COOPERATIVE FORUM

By Steve Schroeder, CPA, MBA, Senior Tax Manager, Eide Bailly, LLP, Fargo, North Dakota The 2017 Tax Cuts and Jobs Act mandates a 21% tax rate for the taxable income of all corporations, including cooperatives. As provided in Internal Revenue Code Section 15, fiscal year entities will calculate their income tax for the fiscal year ending in 2018 using a blended tax rate combining the new and old tax rates. For cooperatives that have paid income tax on patronage income and have made nonqualified allocations of patronage income or unit retains, the reduction in corporate tax rates provides an opportunity to reclaim some taxes that were paid in prior years.

The Revenue Act of 1962 (P.L. 87-834) substantially revised the income tax treatment of cooperatives and their patrons. The purpose of the cooperative provisions in the Revenue Act of 1962 was to ensure amounts earned by a cooperative in the course of its cooperative business activity were included in the taxable income of either the cooperative or the patron, subjecting cooperative earnings to a single level of tax. Section 1383 was included in the Revenue Act of 1962 and amended in 1966 to provide that if a cooperative paid tax on nonqualified allocations of patronage income or unit retains, the cooperative would receive a tax deduction worth as much as the tax originally paid when it redeemed those nonqualified items.

For example, if a cooperative paid tax in 2000 on nonqualified patronage items at a 34% rate and those items are redeemed in 2018, it will receive a credit for that redemption based upon Winter 2018 | The Cooperative Accountant

the 34% tax rate originally paid and not the lower 2018 corporate tax rate. Many cooperatives use nonqualified patronage dividends and nonqualified unit retains as a way to replenish revolving capital. If those nonqualified items have been timely allocated to patrons, tax practitioners who serve cooperatives will have to understand and apply Section 1383 when those items are redeemed. This can be a complex calculation, even in a relatively simple case, and it can provide surprising benefits.

The tax treatment of nonqualified notices of allocation and nonqualified unit retains is straightforward. Nonqualified written notices of allocation and nonqualified unit-retains produce no current tax benefit for the issuing cooperative in the year issued. When a cooperative redeems them, it is entitled to deduct the lesser of the cash paid or the stated dollar amount of the item. If a notice is redeemed in property, the amount of the deduction is limited to the fair market value of the property. When a nonqualified notice is redeemed in the payment period for two or more taxable years, the cooperative must take the deduction in the earlier taxable year. For example, if a calendar year cooperative redeems a nonqualified unit retain on March 1, 2018, the redemption occurs during the payment period for calendar years ending December 31, 2017, and December 31, 2018. The cooperative must take the deduction on the tax return for the year ending December 31, 2017.

Section 1383 is an income tax computation that 31

SECTION 1383 is unique to cooperatives. Subsection (a) provides the following: (a) General rule. − If, under section 1382(b)(2) or (4), or (c)(2)(B), a deduction is allowable to an organization for the taxable year for amounts paid in redemption of nonqualified written notices of allocation or nonqualified per-unit retain certificates, then the tax imposed by this chapter on such organization for the taxable year shall be the lesser of the following: (1) the tax for the taxable year computed with such deduction; or (2) an amount equal to – (A) the tax for the taxable year computed without such deduction, minus (B) the decrease in tax under this chapter for any prior taxable year (or years) which would result solely from treating such nonqualified written notices of allocation or nonqualified per-unit retain certificates as qualified written notices of allocation or qualified per-unit retain certificates (as the case may be).

Two points deserve emphasis under Section 1383. First, Section 1383(a) is a calculation of tax, not of taxable income. Second, Section 1383(a) is not an optional calculation. The section reads, “the tax imposed…shall (emphasis added) be the lesser of the following” and refers to two separate tax calculations.

In determining the decrease in tax for any prior tax year, Treasury Regulation Section 1.1383-1 requires tax attributes to be carried forward or back within the calculation. Treasury Regulation 1.1383-1(b) provides this recalculation rule: (b) Determination of decrease in tax for prior taxable years.

(1) Prior taxable years.− The prior taxable year (or years) referred to in paragraph (a) of this section is the year (or years) within the payment period for which the nonqualified written notices of allocation were paid and, in addition, any other prior taxable year (or years) which is affected by the adjustment to income by reason of treating such nonqualified written notices of allocation as qualified written notices of allocation when paid.

The required recalculation rule creates several challenges. It requires practitioners to recalculate every item of income, deduction and tax credit for the current year without the deduction for currently redeemed nonqualified items, and the tax for all 32

prior affected years as though the nonqualified items had been redeemed (paid in cash) in the year issued. As a result, practitioners must often recalculate the tax for several years.

For example, assume a cooperative which allocates its income based on financial income has allocated $1,200,000 of nonqualified patronage income to its patrons in 2000. Due to accelerated depreciation, also assume that its taxable income was $1,000,000 in 2000. It had no tax credits and paid $340,000 of tax in 2000.

In 2018 it redeemed the entire $1,200,000 of nonqualified allocated patronage issued in 2000.

For this example, the deduction under Section 199A has been treated as distributed to patrons, the cooperative has consistently had $15,000 of charitable contributions each year, and has taken a $5,000 deduction under Section 179 each year.

(See Appendix 1 for calculations.) As expected, the Section 1383 calculation would produce a total tax benefit of $156,000 (13% of $1,200,000), but the reduction in tax would be spread over three prior years (1998, 2000 and 2001). The deduction in 2000 creates a $200,000 NOL carryback to 1998 and $20,000 of carryover deductions (charitable contributions of $15,000 and Section 179 of $5,000) to 2001. The cooperative will report $252,000 of total tax on Line 28 of its Form 1120C and a tax deposit of $408,000 on line 29h.

The tax deposit is treated as a payment on the last day for the payment of tax for the year. If there is a calculation in 2019 for redeeming 2001 nonqualified items, that calculation should begin where the 2018 calculation ends to avoid double counting. See Section 1383(b)(3).

The 2017 instructions for Line 29h of Form 1120-C read as follows: “If the cooperative would pay less total tax by claiming the deduction for the redemption of nonqualified written notices of allocation or nonqualified per-unit retain certificates in the issue year versus the current tax year, refigure the tax for the years the nonqualified written notices or certificates were originally issued (deducting them in the issue year), then enter the amount of the reduction in the issue years’ taxes on this line. Attach a statement showing how the adjustment was figured. This adjustment is treated as a payment, and any amount that is more than the tax on line 28 will be refunded.”

The word “prior” in Section 1383(a)(2) prevents a circular Section 1383 benefit. Suppose in 2016 a cooperative redeemed a nonqualified notice of allocation from 2014, a year when there Winter 2018 | The Cooperative Accountant

SECTION 1383 were charitable contributions. If the result of recalculating the 2014 taxable income is that the contribution is disallowed, the word “prior” in Section 1383(a)(2) would mean that the deduction should be considered for calculating 2015 taxable income, but it appears that it could not be used to reduce 2016 taxable income.

If redemption of a nonqualified item produces a tax benefit under Section 1383, that redemption may not be used for any other purpose. If a cooperative redeemed a nonqualified unit retain in 2018 and received a benefit by recomputing the tax for a prior year, it may not also deduct the redeemed nonqualified unit retain to compute a 2018 net operating loss.

When a cooperative redeems nonqualified notices of allocation or nonqualified unit retains from several years in the same year, it must make a single Section 1383 calculation for both redeemed amounts. Treasury Regulation Section 1.13831(d) provides an example where a cooperative redeemed nonqualified notices for 1964 and 1965 in 1966. The regulation clearly says the cooperative may not use one method (recalculate prior year tax liability) for the 1964 notices and another method (current deduction) for the 1965 notices in 1966.

Since a single calculation is mandated by Treas Regulation Section 1.1383-1(d), careful planning is required to obtain the maximum tax benefit from the redemption of several years of nonqualified notices of allocation in the same year.

Practitioners must research all relevant old and new tax rules and rates. Although payments made to patrons as unit retains or patronage dividends are not considered in calculating Qualified Production Activities Income and the Section 199 taxable income limitation, collateral adjustments for carryovers of tax attributes may change the domestic production activities deduction in the carryback year. Alternative minimum tax should also be considered and included in the calculation provided with the tax return if relevant. If there were tax credits, consideration needs to be given as to whether these credits carry over or are lost.

Section 199A will apply to years after 2017.

Treasury Regulations promulgated under Section 1383 may create state tax issues not contemplated by practitioners. Treasury Regulation Section 1.1383-1(a)(2) reads as follows: If the cooperative organization computes its tax for the taxable year under the provisions of section 1383(a)(2) and subparagraph (1)(ii) of this paragraph, then no deduction under section Winter 2018 | The Cooperative Accountant

1382(b)(2) or (c)(2)(B) shall be taken into account in computing taxable income or loss for the taxable year, including the computation of any net operating loss carryback or carryover. However, the amount of the deduction shall be taken into account in adjusting earnings and profits for the taxable year.

Since Federal taxable income is the beginning point for computing state tax liabilities in most states, removing the deduction for the redemption of nonqualified items could increase state taxable income. Section 1383 is titled “Computation of Tax” and only discusses tax calculations. Many states only allow adjustments for items specifically enumerated in state statute. A literal reading and application of Treasury Regulation Section 1.1383(a) (2) may create problems for reporting state income taxes if the federal taxable income shown on Form 1120-C does not include the deduction for nonqualified items paid. Since Section 1383 applies only to the federal tax calculation, practitioners will have to take care to avoid duplicate reporting of state taxable income.

At this time there is no prescribed format for a Section 1383 statement. A columnar presentation showing patronage and non-patronage income separately for each affected year may be helpful for calculating the current tax and prior benefit and may reduce IRS correspondence. Separate sections should show the results with and without the deduction for nonqualified items. (See the example in Appendix 1.) A copy of restated tax returns is not required by the regulations, so the statement format provided in Appendix 1 should be sufficiently detailed to support a claim for refund.

The use of nonqualified patronage dividends, nonqualified notices of allocation and nonqualified unit retains allows cooperatives to build capital and value without passing the tax burden to patrons.

When cooperatives redeem these nonqualified items, tax practitioners need to maximize the value of those redemptions by reviewing current and prior year tax returns and applying the rules of Section 1383. The 2018 tax rate reduction should provide immediate cash benefits to cooperatives which take advantage of the rules of Section 1383. Practitioners should also consider whether Section 1383 applies any time nonqualified items are redeemed. Tax benefits will be maximized if timely written nonqualified notices are provided to patrons as a matter of course, just as notices are issued when cooperatives pay qualified patronage dividends or withhold qualified unit retains.

33

34

Change In Tax Cumulative Change

Tax

Schedule G, Line 11

Combined taxable income

820,000

0 0 (180,000)

0 1,000,000

Section 1383 Regular taxable income adjustments: Reclassify payment of nonqualified patronage from 08/31/18 to year issued Reclassify payment of nonqualified unit retains from 08/31/18 to year issued Subtotal

Correlative adjustments: Charitable Contribution disallowed (or carried over) Section 179 disallowed or (carried forward) Less NOL carryback due to Sec 1383 recalculation Allowable deduction under Section 199A Taxable income as recomputed under Section 1383

1,000,000

Combined taxable income

5,000,000 (5,000) (15,000) (3,780,000) (3,800,000) 1,200,000 (200,000) 1,000,000 0 0 1,000,000

(61,200) (61,200)

278,800

820,000

0 0 0 0 0

0 0

0

0

15,000 5,000 0 0 (180,000)

0 (200,000)

(1,200,000)

1,000,000

(340,000) (401,200)

0

(180,000)

0 0 0 0 0

0 0

0

0

340,000

340,000

0 0 0 0 0 0 0

0

1,000,000

5,000,000 (5,000) (15,000) (3,780,000) (3,800,000) 1,200,000 (200,000) 1,000,000 0 0 1,000,000

December 31, 2000 Patronage Non-Patronage

1,000,000

0 0 0 0 0 0 0

0

December 31, 1998 Patronage Non-Patronage

Regular Taxable Income Including Section 1383 Adjustments: Schedule G, Line 10 Regular taxable income as last determined before Section 1383 adjustments

Income Tax

Schedule G, Line 11

Schedule G, Line 5 Total income Schedule G deductions: Section 179 deduction Schedule G deductions, Charitable Contributions Schedule G, other deductions Schedule G, Line 6c Total deductions Schedule G, Line 7 Line 5 less Line 6c Schedule G, Line 8 Deductions under Section 1382 Schedule G Line 7 minus Line 8 Schedule G, Line 9a Net operating loss Schedule G, Line 9b Dividend received deduction Schedule G, Line 10 Taxable income

Taxable Income Before Section 1383 Adjustment

ABC Cooperative FEIN XX-XXXXXXX-Section 1383 Calculation Form 1120-C, Farmers Cooperative Association Income Tax Return For the Year Ended December 31, 2018

(15,000) (5,000) 0 0 980,000

0 1,000,000

0

1,000,000

5,000,000 (5,000) (15,000) (3,980,000) (4,000,000) 1,000,000 0 1,000,000 0 0 1,000,000

(6,800) (408,000)

333,200

980,000

0 0 0 0 0

0 0

0

0

340,000

1,000,000

0 0 0 0 0 0 0

0

December 31, 2001 Patronage Non-Patronage

1,200,000

0 0 0

1,200,000

1,200,000

0

6,000,000 (5,000) (15,000) (4,780,000) (4,800,000) 1,200,000 (1,200,000) 0 0 0 0

252,000

252,000

1,200,000

0 0 0 0 0

0 0

0

0

0

0

0 0 0 0 0 0 0

0

December 31, 2018 Patronage Non-Patronage

SECTION 1383

Winter 2018 | The Cooperative Accountant

NATIONAL DIRECTORS Kent Erhardt Director Great Lakes Chapter

Mark Feldman Director Mississippi Valley Chapter

Jo Ann Fuller Director South Atlantic Chapter

Erik Gillam* Director Pacific Northwest Chapter

April Graves, CPA* Director Texas Chapter

Jeff Krejdl Director Mid-West Chapter

Eric Krienert, CPA Director Far West Chapter

Tucker Lemley Director Electric Co-op Chapter

Emery Lewis Director Mississippi Valley Chapter

Michael Mayhew, CPA Director North Central Chapter

Christy Norton, CPA Director Far Western Chapter

Lynn Smith Director North Central Chapter

* Executive Committee Member For a complete listing of National Directors and Committees, please visit www.NSAC.coop

Winter 2018 | The Cooperative Accountant

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National Society of Accountants for Cooperatives 136 Keowee Street Dayton, Ohio 45402 Phone: (937) 222-6707 Fax: (937) 222-5794 www.nsac.coop

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Winter 2018 | The Cooperative Accountant