Today's CPA March/April 2014 by The Warren Group

Today’sCPA MARCH/APRIL 2014

T E X AS S O C IET Y OF

C ERT I F I ED P U BL IC AC C OU N TANT S

OPPORTUNITY COSTS: A Tool to Make Better Business Decisions

The Potpourri of Professional Certifications in Accounting: What Do They Stand For? Overstating Sales Creating Revenue Through the Consolidation Process Shareholders’ Earn-Outs and Earnings Management SEC Climate Change Risk Disclosures

Also: Midyear Board of Directors Meeting

WHAT CAN YOU EXPECT

FROM TSCPA BESIDES

New Member Benefit Radiate360 is an easy-to-use digital marketing platform that enables CPAs to manage their

web presence, social media accounts, business directory listings, online reputation and digital/mobile media campaigns – all within one interface. For more information, a demo or to set up a meeting, visit http://www.radiatemedia.com/tscpa, or contact Robert Hernandez at 866-825-9005 or Robert.Hernandez@RadiateMedia.com.

Pearl Insurance

Liberty Mutual

TSCPA has partnered with Pearl Insurance to offer the TSCPA Member Insurance Program. The program offers a variety of personal and professional insurance plans, including the TSCPA Private Health Care Exchange. Go to http://tscpainsure.org/.

Homeowners and auto insurance ID Number: 7026. 800-524-9400

Discount Sports Tickets TSCPA has arranged deals with the San Antonio Spurs, Houston Rockets and Dallas Mavericks. Visit the Member Benefits Marketplace at tscpa.org.

Personal and Career Development

TSCPA Magazine Subscription Program

Cutting-Edge Professional Information and CPE

Discounts on magazine subscriptions 800-603-5602

Enhancing the Image of the CPA Profession

Full service financial institution 800-843-5295, www.texanscu.org

Recruiting New Members to the Profession Protecting the CPA Certificate You can expect special deals and discounts

Texans Credit Union

Paychex Partner Program

Becker CPA Review Direct Bill Program Save $600 per staff member off the cost of the full four-part CPA review course. Contact tkimble@becker.com

CPA Exam Review Discounts For a complete list of exam review discounts available, visit the Member Benefits Marketplace at tscpa.org.

InterCall Exclusive rates on audio and web conferencing services. 1-800-636-2377

CareerBank.com Online career center for accounting and finance professionals. tscpa.careerbank.com

Payroll processing. 877-264-2615

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Tech Depot Discounts on computer and technical products 888-289-6424

Infinet, Inc. AntiSpam/AntiVirus Protection 214-446-0089

Accurate Forms & Supplies Discounts on computer supplies and tax forms 800-777-0072

Monroe Systems for Business Discounts on calculators and other supplies www.monroe-systems.com

Bank of America TSCPA credit card programs – Platinum MasterCard, CPA logo and other benefits. 800-932-2775

FedEx Office Discounted pricing on most services 646-302-9242

Quest Membership Program Save 50 percent on your next hotel bill 800-STAY450

Office Depot Discounts on office supplies 201-253-5215

AXA Equitable TSCPA Members’ Retirement Program – Members are waived $25 enrollment fee. 800-523-1125, www.axa-equitable.com/mrp

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Roger CPA Review Direct Billing Receive all the enrollment benefits associated with TSCPA membership and have the cost of the course billed to your firm. Visit the Member Benefits Marketplace at tscpa.org.

Please visit the Member Benefits Marketplace at tscpa.org for complete information and links to each of our Member Discount Programs.

Questions? Contact the Member Benefits Administrator at 1-800-428-0272 ext. 216 or craffetto@tscpa.net.

Contents

CHAIRMAN William Hornberger, CPA

EXECUTIVE DIRECTOR/CEO John Sharbaugh, CAE

MARCH/APRIL 2014 VOLUME 41, NUMBER 5

EDITORIAL BOARD CHAIRMAN Winford Paschall, CPA

Staff MANAGING EDITOR DeLynn Deakins ddeakins@tscpa.net 972-687-8550 800-428-0272, ext. 250

TECHNICAL EDITOR C. William Thomas, CPA, Ph.D. Bill_Thomas@baylor.edu

COLUMN EDITORS Greta P. Hicks, CPA Mano Mahadeva, CPA, MBA James F. Reeves, CPA C. William (Bill) Thomas, CPA, Ph.D.

WEB EDITOR Wayne Hardin whardin@tscpa.net

cover story

columns

22 Opportunity Costs: A Tool to Make Better Business Decisions

5 Chairman’s and Executive Director’s Message

Design/Production/Advertising

society features

6 Tax Topics

The Warren Group thewarrengroup.com custompubs@thewarrengroup.com

14 Spotlight on CPAs

7 Business Perspectives

CLASSIFIED

20 Capitol Interest

8 Accounting and Auditing

CONTRIBUTORS Ali Allie; Melinda Bentley; Rosa Castillo; Jerry Cross, CPA; Anne Davis, ABC; Donna Fritz; Wayne Hardin; Chrissy Jones, AICPA; Rhonda Ledbetter; Craig Nauta; Catherine Raffetto; Katey Selph; Patty Wyatt

DIRECTOR, MARKETING & COMMUNICATIONS Janet Overton

Donna Fritz Texas Society of CPAs 14651 Dallas Parkway, Suite 700 Dallas, Texas 75254-7408 972-687-8501 dfritz@tscpa.net

Editorial Board Arthur Agulnek, CPA-Dallas; Kristan Allen, CPA-Houston; James Danford, CPA-Fort Worth; Melissa Frazier, CPA-Houston; Greta Hicks, CPA-Houston; Baria Jaroudi, CPA-Houston; Tony Katz, CPA-Dallas; Jeffrey Liggitt, CPA-Dallas; Mano Mahadeva, CPA-Dallas; Alyssa Martin; CPA-Dallas; Dawne Meijer, CPA-Houston; Winford Paschall, CPA-Fort Worth; Marshall Pitman, CPA-San Antonio; Mattie Porter, CPA-Houston; Kamala Raghavan, CPA-Houston; James Reeves, CPA-Fort Worth; Barbara Scofield, CPA-Permian Basin; Brinn Serbanic, CPA-Central Texas. © 2014, Texas Society of CPAs. The opinions expressed herein are those of the authors and are not necessarily those of the Texas Society of CPAs. Today’s CPA (ISSN 00889-4337) is published bimonthly by the Texas Society of Certified Public Accountants; 14651 Dallas Parkway, Suite 700; Dallas, TX 75254-7408. Member subscription rate is $3 per year (included in membership dues); nonmember subscription rate is $28 per year. Single issue rate is $5. Periodical POSTAGE PAID at Dallas, TX and additional mailing offices. POSTMASTER: Send address changes to: Today’s CPA; 14651 Dallas Parkway, Suite 700; Dallas, TX 75254-7408.

Today’sCPA

| MARCH/APRIL 2014

A Naturalized Texan A Peek at the 2015 Legislative Session

technical articles 27 The Potpourri of Professional Certifications in Accounting: What Do They Stand For? 32 Overstating Sales – Creating Revenue Through the Consolidation Process 35 Shareholders’ Earn-Outs and Earnings Management 40 SEC Climate Change Risk Disclosures

Carefully Crafted for Business and Industry Members Elections, the Key Word for 2013 Returns Away From the Limelight A Summary of the Changes to the Single Audit Requirements

10 Emerging Issues

Accounting Education 2020: Part 3 in a Series

11 Chapters

Chapter Presidents Discuss Business, Industry and Nonprofit Careers

departments 15 Take Note 46 Classifieds See the digital version of

Today’sCPA MARCH/APRIL 2014

OF TEX AS SO CIET Y

AC C OUNTAN T S CERTIFIE D PUBLIC

OPPORTUNITY COSTS: A Tool Make to Better Business Decisions

Also: Midyear Board of Directo

The Potpourri of Professional Certifications in Accounting: For? What Do They Stand Overstating Sales Creating Revenue Through the Consolidation Process and Shareholders’ Earn-Outs t Earnings Managemen SEC Climate Change Risk Disclosures

rs Meeting

Today’s CPA online at tscpa.org. 3

DON’T STRESS We Have the Tools You Need This TAX SEASON We’ll help you make it to April 15 unscathed by providing insights on key tax issues, convenient e-alerts on possible last-minute IRS rules changes, and key practice aids and technical resources you’ll need for a more efficient busy season. Sample a few of our tax season survival resources now — FREE, including: checklists, webcasts and guides.

Chairman’s and Executive Director’s Message By William H. Hornberger, CPA | TSCPA Chairman & John Sharbaugh, CAE | TSCPA Executive Director/CEO

Carefully Crafted for Business and Industry Members Are you aware that nearly 40 percent of TSCPA’s members are employed in business, industry, education and government? That represents a substantial number of members, all working in diverse areas and industries. In this issue of Today’s CPA magazine, we focus on highlighting topics of interest to business and industry CPAs, as well as the services, benefits and professional development opportunities that TSCPA provides to this segment of the membership. The Business & Industry Center on TSCPA’s website is a go-to resource for the latest professional news, relevant continuing professional education, connections with other members, research information, and much more. The site has specialized neighborhoods, including CFO, Education, Energy, Healthcare, Government, Service Industry, Internal Auditors, Manufacturing and Nonprofit. The neighborhoods are updated as needed, and B&I members are profiled in each neighborhood. There is also an “Ask a Question” area on the site for members who have a question and want to contact other B&I members for an informal consultation. The Industry Issues blog offers a convenient way to keep up to date on important issues and opportunities impacting the profession. Bill Schneider, CPA-Dallas, authors the blog. It can be accessed in the Business & Industry Center or at www.industry-issues.com. TSCPA’s other blogs are also accessible from the Business & Industry Center. They include the CEO/Executive Director (the Sharblog)

and Federal Tax Policy blogs; new posts are added regularly. Members can connect and start discussions through TSCPA’s groups on Facebook, Twitter and LinkedIn. A LinkedIn group was created especially for B&I members. The monthly Business & Industry E-ssentials newsletter is a benefit for B&I members. Through a free subscription, members receive the e-newsletter, which includes news and information geared to industry CPAs. TSCPA offers hundreds of high-quality CPE opportunities specific to industry in a variety of formats throughout the year. To learn more about them, please visit the CPE area of the website or the neighborhoods in the Business & Industry Center. The TSCPA CPE Foundation and the Accounting CPE Network (ACPEN) Industry Institute provide a catalog of CPE webcasts and webinars accessible via broadband Internet. The online catalog is available at http://tscpa.acpen. com/category/acpen-industry-institute. The programs were developed to meet the specific needs of CPAs who work in business and corporate environments. The cutting-edge courses are easy to access, engaging and interactive. To bring an additional opportunity for B&I members to network and learn, TSCPA schedules behind-the-scenes company tours. The tours have included visits to Rangers Ballpark in Arlington, the AT&T Performing Arts Center in Dallas

and the Saint Arnold Brewing Company in Houston. Additional tours are being planned for the Austin, San Antonio, Central Texas and Southeast Texas chapters. Members in business and industry should also consider acquiring the Chartered Global Management Accountant (CGMA) designation. AICPA and the Chartered Institute of Management Accountants (CIMA) established the CGMA as a global designation that elevates the profession of management accounting around the world. Those who hold the designation are part of a community of professionals who share best practices, create innovation and are better prepared to meet the global challenges in today’s business environment. To learn more, including the qualifications and costs, please visit their website at cgma.org. The designation is available to qualifying AICPA members, and TSCPA members who are also AICPA members receive a discount. Texas CPAs work in a myriad of companies and organizations, large and small. They are key members of the management team wherever they’re employed. Since one size does not fit all for such a diverse group of members, TSCPA has carefully crafted services, benefits and CPE to address the various needs of those employed in business and industry. To learn more, be sure to visit the Business & Industry Center on TSCPA’s website at tscpa.org. ■

Willie Hornberger can be contacted at whornberger@jw.com. John Sharbaugh can be contacted at jsharbaugh@tscpa.net.

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Tax Topics By Greta Hicks, CPA | Column Editor

Elections, the Key Word for 2013 Returns As we are breezing through tax returns this spring, it is important to STOP and consider several important elections that have a long-term effect on our clients. EXPENSE VS. CAPITALIZE ELECTION At the top of the list is the new repair regulations election. It should read, “In accordance with Internal Revenue Code Sections 167 and 168 and related regulations, XYZ Company has determined that amounts whose individual cost (including tax, installation and delivery costs) does not exceed $500* will be deducted as incurred as an operating expense.” This policy is an annual irrevocable election and must be included with the timely filed federal tax return upon adoption. The regulations are effective for tax years beginning after Jan. 1, 2014, but may be used for the 2013 tax year. For companies with certified financial statements, insert $5,000 versus $500. The $500 is a per line item on the invoice and not the total amount of the invoice, and it is recommended that the election be attached to 2013 returns. Recommendation: Read these 87 pages of regulations. There is a lot of information that we need to know hidden in the chatter. PASSIVE ACTIVITIES The interaction between the Unearned Income Medicare Contribution, IRC 1411, and the Passive Activity Rules, IRC 469, may trigger a need to reevaluate the grouping of passive activities. Taxpayers whose income exceeds the threshold limits and who had Net Investment Income (NII) may regroup activities by making on their 2013 tax year a one time new grouping election. Note: Passive activities are subject to the Medicare tax unless the taxpayer is: • A real estate professional (material participation). • In a real property trade or business – election to treat all interests in rental real estate as one activity, Rev Proc. 2010-13. S CORP ELECTION S corp elections and revocations are due anytime during the taxable year and before the 16th day of the third month of the taxable year and will be effective the following tax year. Elections to become an S corp are made under § 1362(a) on Form 2553. REVOKING S CORP ELECTION Many taxpayers rush out and elect for the LLC, LLP, etc. to be taxed as an S corp when they could be a disregarded entity and file as a soleproprietorship. In Texas, a community propery state, a husband and wife are considered a single owner LLC electing to be disregarded. See Form 8832 for details on how to make elections for your LLC or LLP. The manner of revoking an S corp election is discussed in § 1.13626(a)(3), and requires the corporation to file a statement that the corporation revokes the election made under § 1362(a). The statement must be filed with the service center where the election was properly filed. The revocation statement must include the number of shares of stock issued and outstanding at the time the revocation is made. A revocation may be made only with the consent of shareholders who, at the time the revocation is made, hold more than one-half of the

number of issued and outstanding shares of stock of the corporation. For details on making a revocation, see Chief Counsel Memo Number: INFO 2002-0010, Release Date: March 29, 2002. LIKE-KIND EXCHANGE BASIS ELECTION “Do you want to “Elect OUT of regs under Sec l.l68.(i)-6(i)?” This election is on each and every asset entry sheet and is to be answered each time an asset is acquired. If you’ve missed it, here is what it means, generally. Reg §1.168(i)-6 was passed in February 2007 and is related to the basis of property acquired in like-kind exchanges and involuntary conversions, which means each time a client trades in a car, tractor or truck. The regs are 20-plus pages long and will put you to sleep quickly, but it is important to be aware of their contents. SPECIAL DEPRECIATION ALLOWANCE ELECTION Three more statements that need answers are: “Percentage for special depreciation allowance, 100 percent or 50 percent.” “Elect OUT of special depreciation allowance.” “Elect 30 percent in place of 50 percent special A depreciation allowance.” All three choices or elections are related to the special depreciation allowance, which has been in the Code since 2007 and has once again been extended to cover assets purchased in 2013. The “special depreciation allowance” is Code Sec. 168(k) and allows a taxpayer to elect an up-front first-year write off of 50 percent of the cost of “qualified property.” The special depreciation allowance applies only for the first year the property is placed in service. The allowance is an additional deduction that is taken after any Sec. 179 expense deduction and before regular depreciation is calculated under the modified accelerated cost recovery system (MACRS). Certain qualified property acquired after Dec. 31, 2007, and placed in service before Jan. 1, 2014 includes: • Tangible property depreciated under MACRS with a recovery period of 20 years or less. • Water utility property (see 25-year property). • Computer software defined in and depreciated under Sec. 167(f) (1). • Qualified leasehold improvement property SECTION 179 EXPENSE ELECTION In addition to tangible personal property, taxpayers can elect to expense certain qualified real property the first year placed in service as Sec. 179 property for tax years beginning in 2013. There are earned income limitations, taxable income limitations and annual maximums that change each year. TAKE CARE An election is a decision of the taxpayer. As return preparers, we should make our clients aware of the options available, and the advantages and disadvantages of each option. ■

Greta Hicks, CPA, is a consultant on IRS problems, seminar discussion leader, author of continuing education courses and web content provider. She can be reached at gretahickscpa@yahoo.com or www.gretahicks.com.

Today’sCPA

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Business Perspectives By Mano Mahadeva, CPA, MBA | Column Editor

Away From the Limelight Most companies benefit from buoyant debt markets, low interest rates, and rising equity markets. However, corporate reforms, increased regulations, decreased valuations, and misplaced strategies have minimized these benefits, causing discomfort for some to remain in the public eye. Dell, which lost nearly half its stock value in the market, went private after a long-standing battle with activist Carl Icahn. BlackBerry (formerly known as Research in Motion), battered by competition from the Apple iPhone and Android systems, went private in the aftermath of its stock market value collapse over the past few years. Does it make sense to go private? Yes, it would if a company has: a healthy and sound business; a consistent and reliable cash flow to pay down significant future debt service; not been rewarded by the investor community; an inexpensive share price; major share price volatility; poor coverage by analysts; a wellrespected senior management team; and a group of investors with the appropriate amount of capital. The possible advantages of going private are many. Management has the freedom to focus on the business model. They have the flexibility and time to restructure operations and an ability to focus on long-term growth. Being private provides confidentiality and protection for the company from divulging sensitive financial or operational information to competitors or start-ups. It also offers the potential to reduce litigation risk. The best features may be the potential exemption from the Sarbanes-Oxley Act, less pressure to meet Wall Street growth expectations, and greater ownership for management. Going private may have disadvantages, due to litigation arising from minority shareholders. There could be hefty transaction costs from three groups (acquired company, special committee,

and acquiring company). Accessing capital may be difficult. And employees could be disappointed and unmotivated going forward. Companies challenged in financial performance because of over leverage, unreliable cash flow or which have a faulty business model are not the ideal candidates to go private. A company can go private in different ways, such as an open market transaction, a tender offer, a merger, a leveraged buy-out, an employee stock option ownership plan or a reverse stock split. An open market transaction occurs when investors buy the company shares on the open market. In effect, the identity of the buyer is unknown, the board needs to approve the purchase and the buyer needs to comply with Securities and Exchange Commission (SEC) regulations and filings. The tender offer is made by the company or an outside investor group to purchase some or all shares of the company. The number of shares to be purchased is identified, and purchases are made based on the lowest price within a specified range. The merger follows on the heels of a successful tender offer when the purchaser of stock obtains voting control. The dissenting group is bound to sell its shares, but several states have enacted provisions to protect the rights of this group. A leveraged buyout occurs when a company is taken private by outside investors who finance the purchase of shares against the assets of the company. Management could be included in the buyout, but is usually offered an equity

interest in the leveraged company. An employee stock option ownership plan operates in a similar manner to an LBO, in that it borrows money, guaranteed by the company, and uses this money to buy the company’s shares. And in a reverse stock split, each outstanding share is converted into a fraction of a new share. The goal here is to have no more than a specific number of shareholders to go private. This method is very expensive and rarely used. A company considering going private usually appoints a special committee from its board of directors. These individuals have to be “independent,” because the buyer could be comprised of management and/or board members. This committee is charged with arm’slength negotiations with the acquirer, to protect minority shareholder interests and to ensure that fair consideration is paid. The SEC reviews the proxy statement, the document which typically explains the transaction and reasons for going private. The SEC rules are complex and require the purpose of the transaction, all disclosures relating to the transaction, reasons for going private with alternatives (if any), appraisals of the transaction, and plans and pro forma information about the future. If a company goes private, can fix its problems and grow its business, it should be able to reap rewards if it desires to go back into the public arena in the future. This action requires an honest and serious discussion and evaluation by the board and shareholders. This is where we, the CPAs, can help guide the key decision makers along the better path. ■

Mano Mahadeva, CPA, is Chief Financial Officer with Solis Health in Addison, Texas. He serves on the Editorial Board for TSCPA. Mahadeva can be reached at mmahadeva@solishealth.com.

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Accounting and Auditing By Leita Hart-Fanta, CPA, CGFM, CGAP | Guest Columnist

A Summary of the Changes to the Single Audit Requirements On Dec. 26, 2013, the federal government published a comprehensive document that impacts administrators and auditors of federal grants. The title of the new regulations is “Uniform Administrative Requirements, Cost Principles and Audit Requirements for Federal Awards.” Here is the link to the document: www.gpo.gov/fdsys/pkg/FR-2013-12-26/ pdf/2013-30465.pdf. If this is an area that directly impacts your work, you will want to read the document yourself. The following list of significant changes is biased toward concerns for auditors, not concerns for administrators of these grants or pass-through entities. Please keep an eye on the American Institute of CPAs (AICPA) Government Audit Quality Center for their guidance regarding the changes. 1. Consolidates eight regulations into one. The feds have finally consolidated all of the cost principles, administrative principles and audit requirements in one document. Where there used to be eight places the regulations could appear, including the Code of Federal Regulations and Office of Management and Budget Circulars, now you only have to reference one very long document – over 100 pages long. See section II.1. 2. Syncronizes terms and acronyms. Part 200, subpart A contains a list of acronyms and terms that will be used throughout the document and for all entities involved in the grants management process. One of the most difficult aspects of taking on the single audit is the litany of acronyms and terms you must master to have a decent conversation on the topic. This glossary of terms and acronyms should help. For most of 2013, those watching the federal government thought that the acronym CFDA would be replaced with the term CFFA, but this did not happen. CFDA stands for Catalog of Federal Domestic Assistance; CFFA was to stand for Code of Federal Financial Assistance. 3. Clarifies some guidance. The feds want to reduce the number of findings that result from a minor technicality regarding 8

the interpretation of unclear guidance. Auditors often run into problems interpreting federal guidance and have trouble applying it to their audit clients. This can lead to a nasty disagreement with the client about a fuzzy part of the regulation. Here is an example of a small change that could stop a few unnecessary arguments: In the auditing standards (section 200.514 (d) (1)), the feds make it clear that they are not concerned with compliance with all laws and regulations as stated in the superceded OMB Circular A-133 – only the federal laws and regulations. 4. Addresses recent bad behaviors. Employee morale costs are now prohibited and conference guidelines have been rewritten to help make clear that grantees shouldn’t charge the taxpayers for parties in Vegas (can anyone say IRS?). See section B: Discussion of section 200.437. Concerns regarding controls over personally identifiable information are also woven throughout the standards. 5. Includes a few pet projects. An interesting management initiative or two has made it into regulations, including “family friendly policies” to help employees with expenses related to childcare when they attend conferences. See section B: Discussion of section 200.432 and section 200.432. 6. Tweaks expectations regarding internal controls. The federal government, like all of us, is seeking to strike a balance between burdensome bureaucracy and reasonable controls. In some cases, they seem to be asking for more stringent controls and in other places, they are lightening up. These are just a few examples: • Tighter controls – The long-existing coverage of internal controls using COSO (the Committee of Sponsoring

Organizations of the Treadway Commission’s Internal Control Integrated Framework) in Part 6 of the compliance supplement is now specifically referenced in the auditor section 200.514, pounding home the importance of the auditors’ work regarding internal controls over federal programs. The discussion in the compliance supplement is not new – the reference to it in the audit requirements is new. See Section 200.514 (c) (1). • Fewer controls – Computing devices under $5000 are classified as “supplies” and not “equipment” to reduce administrative burden. See Section 200.94. • Depends on who you are – Section 200.430 covers “compensation” and goes on for several pages. When you add it to section 200.431 on fringes, you end up with four-plus pages of text. Is this more or fewer controls? Depends on who you are and how tight your controls are now. These are sections worthy of detailed study for both administrators and auditors. 7. Syncs up concepts with GAGAS. The GAO’s yellow book (GAGAS – Generally Accepted Government Auditing Standards) has been revised several times since the last time the single audit requirements were revised. Now, the single audit requirements are catching up and emphasizing important GAO concepts, including: • Abuse – Abuse is now formally mentioned in the federal regulations as a reportable condition along with fraud, internal control weaknesses and noncompliance. Abuse has been a reportable condition under GAO standards for about 10 years. Abuse is behavior that is deficient or improper in contrast with the behavior of a Today’sCPA

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prudent person. See section 200.516 (a) (1). • Cause – The GAO has always mentioned cause as one of the elements of a finding, but OMB Circular A-133 mentioned it in a very passive way, asking that the auditor give the reader enough information to determine the cause of a finding. The new requirements now clearly indicate that the auditor is responsible for expressly stating the cause in each audit finding. See section 200.515 (b) (4). • Effect – More specific and descriptive language was added to further describe the importance of detailing the effect of each finding. See section 200.515 (b) (5). 8. Requires additional auditor transparency: • Sampling – Single audit requirements have always asked auditors to describe their sample sizes and testing results in their findings. Now the feds have tacked on another requirement that the auditor describe whether the sample was statistically valid. This may cause auditors to change their sampling methods from judgmental sampling to statistical sampling. Section 200.515 (b)

(7). • Peer review – Grantees must request a copy of the auditor’s latest peer review report as they select an auditor (see section 200.509). 9. Raises thresholds for the: • Trigger of the single audit – Grantees expending more than $750,000 during the entity’s fiscal year must undergo a single audit (see section 200.501 (a)). The federal government notes that this still achieves audit coverage on over 99 percent of federal dollars currently covered. Do not read that to say that 99 percent of federal expenditures are covered. It says that 99 percent of funds currently covered using the current threshold are still covered. This change will eliminate the need for 5000 single audits! • Reportable questioned costs – The questioned cost threshold was $10,000 and now it is $25,000. See section 200.516 (a) (3). 10. Rewords the steps regarding the determination of major programs. The guidance has always made it seem that choosing which programs to audit (major programs) is very straightforward and a

matter of taking four simple steps. That is so misleading! The process is an involved mess. The bigger the entity and the more grants they have, the messier the process gets. The slight changes in wording may make a difference to which programs are chosen for audit. See section 200.517. 11. Disallows charges for financial audits that are not related to the single audit. The cost of a financial audit of an entity that receives federal funds but does not trigger the single audit can’t be charged directly to the program, although the cost may enter into the calculation of indirect cost rates. Pass-through entities that utilize agreedupon procedure engagements to monitor sub-recipients that do not meet the single audit threshold must meet strict criteria in order to charge cost of the engagement to the grant. See section 200.425. The committee that created the changes stars in a 30-plus minute video that covers the major changes. It’s available at www. youtube.com/watch?v=xBmjulDwDWk &feature=youtube. There has also been discussion of reducing the number of compliance items from 14 to six, but this will not be finalized until the compliance supplement is published this spring. ■

Leita Hart-Fanta, CPA, CGFM, CGAP, is the founder of Yellowbook-CPE.com.

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Call A Texas CPA Today! North Texas The Holmes Group Toll-Free 1-800-397-0249 ryan@accountingpracticesales.com Central & West Texas Bill Anecelle Toll-Free 1-866-809-8705 bill@accountingpracticesales.com Southeast Texas Gary & Wade Holmes Toll-Free 1-888-847-1040 garyh@apsleader.com www.AccountingPracticeSales.com

Emerging Issues By James F. Reeves, CPA | Column Editor

Accounting Education 2020: A Stakeholder’s Perspective Part 3 in a Series: The Cloudy Crystal Ball

While pressure from parents, students and politicians for $10,000 degree programs is intensifying, accounting education finds itself in a fertile, dynamic environment with unprecedented opportunities to extend its value proposition. Two recent professional studies have underscored the need for accounting education to evolve to meet the future needs of key constituents. Among the key conclusions identified by the American Institute of CPAs (AICPA) CPA Horizons 2025 project was that while accounting education is a cornerstone of the profession throughout one’s career, it needs to evolve beyond technical accounting knowledge. Problem solving, communication and collaboration, and leadership skills will be increasingly important. A separate project by the Pathways Commission, a joint undertaking of AICPA and the American Accounting Association, issued a report in 2012, titled Charting a National Strategy for the Next Generation of Accountants. The report concluded that what is needed is a purposeful integration of accounting research, teaching and practice, and that curricula needs to be integrated with real-life business issues and processes, providing context where accounting provides key information for decision making. DISRUPTIVE TECHNOLOGIES AND DELIVERY MODELS Nothing is going to do more to change the traditional educational paradigm than the disruptive technologies and delivery models that have been emerging in the last few years. New hybrid delivery models that leverage online platforms and deliver a blended learning experience that combines multiple media and live instruction, the traditional classroom model may see more change in the next decade than it has seen in the last 200 years. For those who don’t fear and even embrace change, the next decade will mark the beginning of a new era of opportunity for accounting educators to extend their value proposition. These new delivery methods will have the impact of “flipping the classroom,” creating an environment where students, instead of coming to class to hear a lecture and then go off to review their notes and prepare for an exam, will go online to review the lecture and take quizzes in bite-sized lessons before coming to class. Students will be able to self-test and review the material until they obtain the desired level of mastery. The classroom experience

will become more interactive, with professors functioning as discussion leaders and coaches. This will, in turn, engage the purchasers of the institutions’ work product – companies and firms hiring accounting graduates, at a deeper level in the educational process, perhaps with unforeseen levels of investment as the “war for talent” is exacerbated by ever-increasing demand for graduates. It will further create new opportunities for faculty who will have the ability to extend their reach beyond the physical limitations of the traditional classroom. Further, massive open online courses will enable institutions and their faculties to disaggregate and re-aggregate curriculum to reach accounting professionals at all stages of their careers, who will be able to purchase college courses on topics of interest “by the drink,” outside of a formal degree plan. Institutions will also be able to combine, or re-aggregate, previously disparate curricula, eliminating the silo effect and providing real-world context not previously possible. Imagine, for example, being able to combine elements of a tax course, an economics course and a political science course to teach students about various tax reform proposals during a presidential election cycle. For a profession with lifetime learning as a core value, these new technologies and delivery models will play an integral role, enabling CPAs to thrive in a fast-changing environment that will only intensify in the years ahead. PROFOUND POSSIBILITIES While the change drivers impacting accounting education are unlike anything we’ve seen before and their potential impact profound, they have the possibility to provide significant benefits to all stakeholders. They will enable institutions and their faculties to extend their reach beyond traditional degree programs. Students, including practitioners at all stages of their careers, will have cost-effective lifetime learning opportunities never before available. And employers will reap the benefits of a better educated workforce and platforms to help employees reinvent themselves to meet their needs in a fast-changing business environment. ■

James F. Reeves, CPA, is Senior Vice President, New Product Development at the Tax and Accounting business of Thomson Reuters. Contact him at jim.reeves@thomson.com, or visit his blog at http://jamesfreeves.blogspot.com.

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Chapters By Rhonda Ledbetter | TSCPA Chapter Relations Representative

Chapter Presidents Discuss Business, Industry and Nonprofit Careers In keeping with the theme of this issue, the column focuses on chapter presidents who work outside of the public practice realm. They provided responses to questions ranging from their first jobs as CPAs to their advice to those entering the profession in the future, as well as how their experiences working in industry have helped them in their current volunteer position. Participating, in alphabetical order by name: Ryan Bartholomee, Permian Basin Chapter; Robin Christian, Fort Worth Chapter; Paul Damerow, Corpus Christi Chapter; Tom DeGeorgio, Houston Chapter; Laura Williams, Southeast Texas Chapter; and Sally Wolfe, Central Texas Chapter. CPA CAREER, JOB RESPONSIBILITIES Reflecting the adaptability required of CPAs, there is great range in the size of organizations these individuals have worked for, from 20 to 50,000 employees. All but one have worked in public accounting at some point since being certified as a CPA. Other jobs held include accounting for a cabinet manufacturer, a rural electric cooperative and a company that builds shrimp peeling equipment. Currently, two work in the energy resources arena – one for an independent oil and gas company, and one for a multinational that produces commodities used in manufacturing and also has oil and gas interests. Others are in diverse industries such as publishing, assessment and talent management, and two work in faith-based nonprofits. There are several stories about interesting job duties or events. • One was about being surprised by the breadth of areas served by the company’s small accounting department, including snowmobile tours and operation of private aircraft in addition to ranching and real estate development. • Another involved driving to dozens of sites owned by the nonprofit to assess damage and work on a plan for reconstruction after a major disaster – then creating a preparedness strategy for inevitable future occurrences. • There was oversight over all tax litigation at a multinational in addition to responsibility for lobbying tax legislation, corporate structuring and contract negotiations. • One included enduring profane expressions of frustration by the machinists when making monthly visits to try to Today’sCPA

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get them to check the correct parts out for the equipment they were building so the equipment could be costed out properly. • But the most unusual experience was shared by Sally Wolfe, CPA-Central Texas. “While in public accounting, I was working at a client’s office where the owner was known to take pleasure in allowing his adult python to roam the office and freely visit guests,” she says. “For two days, I kept a wary eye out for the snake, while trying to maintain my focus on the work at hand. I finally met the owner and asked him where the snake was. He told me they had to have him put down for attacking an employee. I was sad but relieved at the same time.” When discussing a busy season, one person refers to two each year: budgeting March through May and audit preparation July through September. Another refers to a crunch in the amount of time available between receiving updated income tax forms and publishing compliance guidance materials. Two have monthly processes that intensify after the end of the fiscal year. WORK/VOLUNTEER SKILLS AND CHAPTER INVOLVEMENT Several of the participants talk about skills different from those used in the public practice/financial advisor arena that are helping as a volunteer leader. Multi-tasking is one that is universally agreed upon. Another is the ability to look deeper, find the areas where people need help and offer them solutions. Listening to others’ ideas and personal stories and understanding their motivations and passions is an expertise not usually in focus for CPAs. Tom DeGeorgio, CPA-Houston, explains: “I feel that, in industry, you are more responsible for your own development. Building a wide and varied skill set is the key to success.” He adds, “My goal is to grow every day, no matter how large the obstacles.” Paul Damerow, CPA-Corpus Christi, discussed that “in my position, it’s like working with a Breakfast Club movie variety of different personalities. In any day, I feel that people come to me like they go to Google: for information and advice. I’m also a cheerleader/

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Chapters Continued from page 11

Ryan Bartholomee

Paul Damerow

Laura Williams

Robin Christian

Tom DeGeorgio

Sally Wolfe

yell leader, quarterback and counselor, but mostly am there to give an open ear, a warm hug and a shoulder to cry on, all while the accounting work is getting done. And I love all of this?” Most have become involved in their chapter through the encouragement of a specific person. One made the progression to leadership after completion of the chapter’s leadership development program. CAREER REWARDS AND CHALLENGES The conversation shifts gears to the most rewarding aspect of their career. There are varied responses. One person says that adding value for the “customer” (the company owner and other team members), leading others effectively and developing a love for lifelong learning are all fulfilling. The great feeling from giving back, coaching and watching younger staff succeed was referenced. Another talks about working with a great team and knowing at the end of the day that they all are productive and contribute to the success of the company. There is a reference to the fun of problem solving. Putting it into perspective with relation to the world she lives in, Laura Williams, CPA-Southeast Texas, enthuses: “Through my job, I have been blessed to have the opportunity to help several churches that were heading toward financial failure. They were able to take the information I provided them and turn things around to become viable, and return to their mission of serving the community.” She adds, “Giving financial education to employees and priests that helps them become better stewards for their congregations is the most rewarding for me.” A career as a CPA combines rewards with challenges. 12

• Most participants cite the pressure of keeping up with changes in regulations – those for accounting and those for employers in general, such as the Affordable Care Act – and ensuring compliance throughout the company. • Some have to deal with the politics and the endless layers of a large, multinational company. • There is also the challenge of changes in the way some companies prepare and/or deliver their products. • The constant need to develop and delegate to staff was mentioned. CPAs are exceptionally responsible and find they must learn to let go of tasks they handled in the past. This person also goes on to say that much more can be accomplished through and with others. • In addition, Robin Christian, CPA-Fort Worth, says: “A new challenge is the shifting environment of where people get their work done. We have to learn to adapt where we handle our own tasks, and to change how we manage others as the office configuration evolves.” THE NEXT 10 YEARS FOR CPAS WORKING IN INDUSTRY Turning to the future, the group considers the one big thing in the next 10 years that will be a game-changer for CPAs working in industry. One states that quickly evolving technology is changing the accounting department. Executives have financial information available any time and are no longer tied to a desk, freeing them for new and diversified roles. Another refers to an influx of new workers from the echo-boom/millennial generation into companies at a time when many experienced CPAs will delay retirement. Yet another talks about the changes that will result from the combination of leaps in technology with the skill set and naturally different outlook of younger workers. It is envisioned Today’sCPA

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that it will be crucial to be able to work well with people from different generations, ethnicities and backgrounds. How we communicate with each other will change dramatically. A game-changer will be that CPAs will no longer be considered company accountants but, instead, trusted business partners vital to future business success. And one said that a CPA in industry now and in the future will have to remain very flexible to change, think outside the box and try new ideas all the time. ADVICE TO STUDENTS CONSIDERING A CAREER IN ACCOUNTING To close the discussion, the group was asked what advice they would give to students who are considering a career in accounting. Several mentioned that it’s a great jumping-off point for a variety of careers and work options, some of which might not be directly related to accounting. It is suggested that, in addition to preparing to be CPAs, undergrads should focus on understanding how business decisions are made and how

they shape the future. One states that it’s very important for students to consider what they are passionate about and would enjoy doing for much of their working life. And most agree that having a mentor, and getting to know other CPAs and see what they do, is very important as they choose their career. Ryan Bartholomee, CPA-Permian Basin, says: “Ken Coleman has two points that express how I feel. In talking about a career, he says that your sweet spot is at the intersection of your greatest strength and your greatest passion. He also says that if you aren’t in the right place [i.e., your sweet spot], the right time can’t happen. I’m confident that a career in accounting can be the right place, as there are so many things that you can do as a CPA. There is instant respect and amazing opportunities.” Bartholomee adds that he tells students: “Pass the exam as soon after graduation as you can. You don’t want to forget how to study for tests or the material that you learned to complete your degree. This profession needs and wants you, and there are amazingly fulfilling ways to give back to your community using your expertise as a CPA.” ■

Rhonda Ledbetter is the TSCPA chapter relations representative. Contact her at 972-687-8508 or at rledbetter@tscpa.net.

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4/1/13 2:09 PM

Spotlight on CPAs By Anne McDonald Davis, ABC

A Naturalized Texan

Combines Military Service and Love of Teaching to Create a Unique Career and Life As a boy, Tony Riley “devoured” a book called Thirty Seconds Over Tokyo, Cap. Ted W. Lawson’s chronicle of the U.S. offensive after the attack on Pearl Harbor. The riveting description of bombers launching off the deck of an aircraft carrier for the first time in history hooked young Riley on the notion of becoming a military pilot. Unfortunately, his eyes didn’t cooperate. “I didn’t have 20/20 vision,” Riley discloses ruefully. “So that dream went down in flames. At the time, I had no clue what else I wanted to be.” Growing up in Morristown, a small Tony Riley, CPA, town in Tennessee near Knoxville, Riley South Plains would wait to get his career bearings again until he left home in the early 1960s for college. Enrollment at the nearby University of Tennessee proved to be a bad fit; the school was over-enrolled with little on-campus housing and a strong incentive to flunk out any floundering freshmen. When a buddy urged Riley to join him at Virginia Tech, he took a chance. The college cadet corps, similar to Texas A&M in those days, brought structure and discipline to his young adult world. Riley recalls, “It was just what I needed at the time, even though they called us freshmen ‘rats,’” he chuckles. “I got a lot of demerits at first because of my, uh, lack of ‘full military bearing.’ But I soon acclimated to the military lifestyle and my uniform appearance, and my military bearing improved, although I spent a lot of weekends ‘studying off’ my demerits instead of partying.” That early academics-oriented college life proved fortuitous given the results of Riley’s E. K. Strong vocational test; his interests showed a clear alignment with the practice of accountancy, to the young man’s surprise and confusion. “I did not see that coming – had no idea what an accountant was,” Riley admits. “I had a neighbor in Morristown who was a CPA and I didn’t really know what he did. But I enrolled in an accounting class and discovered the test was right!” Riley recalls that financial statements were typed when he began his journey to becoming a CPA, along with a lot of “pencil work on columnar pads.” “I still have a callous on my finger from holding a pencil all those years,” he muses. “I actually liked using a pencil.” SERVING HIS COUNTRY As his education drew to a close, there was no ignoring the ongoing war in Southeast Asia; plus Riley was already part of the Virginia Tech corps. He remembers: “When I graduated in 1965, Vietnam was beginning to escalate. My father and uncles strongly advised me to get an officer’s commission rather than serving as a private.” After a tour in Vietnam, he served as a marksmanship instructor and discovered he had a knack for, and a love of, teaching; he found it “satisfying.” Even after his military service 14

transitioned into reserve status and he embarked on stints in public accounting and as a CPA in business for a series of Fortune 500 companies, Riley kept remembering being a teacher. “When I was in the Army, I taught over 400 recruits at a time and really enjoyed doing that,” he reminisces. “I always thought I might want to teach higher education someday and finally got that chance when I moved to Texas after about 15 years. Having a CPA certificate opened that door for me. I took a job with the American Cotton Growers in Littlefield and also became an adjunct professor at South Plains College.” While west Texas was quite a contrast to his native state, Riley found himself drawn to the endless vistas, noting that the only land that flat in his hometown was the football field at the high school. He claims “naturalized” Texan status after being here for 36 years and by virtue of Morristown native Davy Crockett having fought and died at the Alamo. “I even had some distant relatives fall at the Alamo,” he asserts. “At least that is what my grandmother told me as she heard it from her grandmother.” In 1993, Riley hung up his official teacher’s hat and began serving as vice president of finance and administration for the college. His days are sometimes hectic, supervising a staff of 160 on four campuses covering 15 counties. But the students still come first for him, and he says the CPA code of ethics applies. “As a CPA, the students are my clients,” he says firmly. “There is a personal responsibility to serve your clients. Often, you’re the first CPA a student comes into contact with – first impressions are important. When I was faculty, I interacted with students every day and I still do, even in administration. Students can tell whether you’re trying to help them or just blow them off. That perception is crucial.” A big milestone for his career was recently achieving his Chartered Global Management Accountant (CGMA) designation, which he considers “a privilege” and believes will be a future “must have” for professionals in government and business, especially those on the international scene. ANOTHER BEND IN THE ROAD In June, Riley plans to retire from South Plains after a long accounting career that made room for 30 years’ active service to his country, ending at the rank of lieutenant colonel after assignments spanning Vietnam, Germany and Korea. He has been an active volunteer with TSCPA, especially at the chapter level, and the Society will be fortunate indeed if he finds some time in retirement to continue involvement. His enthusiastic words for his professional organization are encouraging. “We have a very strong state organization that supports its continued on next page

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chapters. We haven’t ever asked TSCPA for help and not gotten it,” he enthuses. But there will be competition for his volunteer service, which has included dedication to the Rotary Club … and playing the trombone. Once part of a regimental band, he now keeps in practice with the West Winds Brass Band in Lubbock, playing concerts in area parks and, naturally, serving as treasurer. Still, his first venture after retiring will be taking a cruise to Alaska with Dorothy, his wife of 21 years. Their blended family includes four children and five grandchildren; sadly, the couple lost one son several years ago. Today, one son lives in Lubbock;

a daughter with three boys teaches in Austin; and another daughter with a boy and a girl lives nearby and keeps the books for her cotton farmer husband. Although Riley says he and Dorothy plan to resume country and western dancing after she recovers from back surgery, there will also likely be many quiet evenings at home reading; he enjoys military history. The South Plains CPA seems quietly content with his long career, both academic and military, and the relationships he formed over the years. “If you treat people like you expect to be treated, that’s about as well as you can live your life,” he smiles. ■

Take Note Accountants Confidential Assistance Network

Membership Recruitment Campaign: Responsibility of Individuals

TSCPA’s Accountants Confidential Assistance Network (ACAN) was created to help Texas CPAs, CPA candidates and accounting students who may be dealing with alcohol, chemical dependency and mental health issues. A 24-hour hotline is available at 1-866-766-ACAN to help people who need assistance. You can also contact TSCPA’s Craig Nauta at cnauta@tscpa.net. By law, all information, communications, reports received, gathered or maintained by ACAN are strictly confidential, so there’s no risk to call. To learn more about the program, please go to TSCPA’s website at tscpa.org, select Resource Center, and then scroll down and click on Accountants Confidential Assistance Network.

The Responsibility of Individuals is TSCPA’s member recruitment and retention campaign. It was established to show Texas CPAs the common responsibility that you share of taking care of the profession. There is strength in numbers and TSCPA can’t exist without you. After all the years you have spent earning and maintaining your CPA certificate, what would happen if your invaluable designation was compromised or destroyed? Several thousand bills are introduced in each Texas legislative session and it’s through your support that TSCPA can protect your interests. People, businesses and legislators listen more to the collective voice of 27,000 than to your individual voice, and TSCPA is the most effective advocate for the CPA profession in Texas. Encourage your nonmember colleagues to join and share with them how that membership in TSCPA is a core responsibility for a serious professional. To learn more, please visit the website at www.tscparoi.org.

2013 Outstanding Educator Award Recipients Recognized

Chartered Global Management Accountant (CGMA) Designation

TSCPA presented four top Texas accounting professors with the organization’s 2013 Outstanding Accounting Educator Award. The award ceremony for this honor was held during TSCPA’s Accounting Education Conference. The awards recognize accounting educators in Texas who have demonstrated teaching excellence and have distinguished themselves through active service to the profession. Congratulations to the recipients:

AICPA and the Chartered Institute of Management Accountants (CIMA) created the CGMA designation for CPAs who work in business, industry and government. This designation elevates the role of management accounting, recognizes the experience and expertise CPAs bring to positions within business, and ensures skills are kept up to date. In addition, AICPA and CIMA provide a variety of resources, research information, and career tools for designation holders, as well as access to a global community of management accountants. The CGMA is available to qualifying AICPA members. Members of TSCPA who are also members of AICPA receive a discount. To learn more, visit their website at cgma.org. Important note: Beginning in January 2015, applicants will be required to successfully complete the CGMA examination to earn the designation.

• • • •

Shawn Miller, CPA – Lone Star College, Cy-Fair Adria Vasquez, CPA – Texas A&M - Kingsville Barry Bryan, Ph.D. – Southern Methodist University Linda Vaello, CPA – University of Texas – San Antonio

For more information about the Outstanding Accounting Educator Award, please go to TSCPA’s website at tscpa.org and click on Students – Educators – Outstanding Accounting Educator Award. Today’sCPA

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Take Note

By Rhonda Ledbetter | TSCPA Chapter Relations Representative

TSCPA Midyear Board of Directors Meeting Members of the TSCPA Board of Directors met in South Padre Island January 31-February 1 to conduct Society business and obtain profession information. • The IRS with a request to reverse its decision to retire disclosure authorization and electronic account resolution from e-Services; • Members of Congress – sent with other state CPA societies – expressing concern about limitations on the use of the cash basis method of accounting proposed in small business tax reform discussion drafts; • The IRS on draft Form 8960, Net Investment Income Tax Individuals, Estates, and Trusts; • Senator Cornyn and Representatives Conaway, Granger, Hall, Hinojosa, McCaul, and Vela for cosponsoring bills to make permanent the deduction of state and local general sales taxes.

TSCPA Executive Director/CEO John Sharbaugh, CAE; Former CPA Helen Sharkey, Speaker; and TSCPA Chairman Willie Hornberger, CPA-Dallas

CHAIRMAN’S REPORT

TSCPA Chairman Willie Hornberger, CPA-Dallas, summarized progress on the organization’s Strategic Plan, which is the foundation for work on behalf of members. Enhancing professional competency, TSCPA’s CPE Foundation continues to offer a variety of continuing education courses and delivery formats across the state. There were more than 1,000 people who obtained the most recent professional issues update offered free to members via the Internet. To meet the diverse needs of members who work in areas other than public practice, there are nine neighborhoods in the online Business and Industry Center. During April, which is B&I month, there will be several promotions and communications aimed at connecting with and engaging B&I members. A brochure was sent to B&I members in the autumn detailing all that TSCPA offers in the way of benefits and continuing professional education (CPE). Last year, two behind-the-scenes tours were held for B&I members, where they learned about a company, toured the business, and participated in networking. More tours are scheduled this year. Fulfilling the advocacy objective, TSCPA works tirelessly to protect CPAs and those they serve. Results of recent legislative efforts, including passage of proposed changes to the Accountancy Act, were reported in a Capitol Interest article in the July/August 2013 issue of this magazine. Another victory was opposition to a sales tax on professional services. TSCPA’s Regulatory and Legislative team is now focused on 2014 elections. Information is continually updated in the Governmental Affairs section of the TSCPA website at tscpa.org. During the first months of this fiscal year, the Federal Tax Policy Committee has issued a variety of letters, some of them to:

You can get updates on their advocacy at the Federal Tax Policy Blog on the website. The Professional Standards Committee has spoken on behalf of Texas CPAs. Just a few examples: • Sent supportive letters to the Financial Accounting Standards Board (FASB) and the Private Company Council (PCC) in response to four proposed recommendations from the PCC: Accounting for Goodwill, Accounting for Certain ReceiveVariable, Pay-Fixed Interest Rate Swaps, Accounting for Identifiable Assets Intangible Assets in a Business Combination, and issued a favorable response to FASB’s and PCC’s Applying Variable Interest Entity Guidance to Common Control Leasing Arrangements; • Submitted a letter, jointly with the FTP committee, in response to the AICPA Professional Ethics Executive Committee’s Revised AICPA Code of Professional Conduct; in the letter, the committees pointed out the Code’s failure to include any reference to the Treasury Circular 230 standards; • Responded to FASB’s exposure draft Leases, questioning whether revisions to the original lease accounting models are necessary; • Submitted a letter to the Public Company Accounting Oversight Board (PCAOB) expressing concern with the exposure draft Proposed Auditing Standards – The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion; The Auditor’s Responsibilities Regarding Other Information in Certain Documents Containing Audited Financial Statements and the Related Auditor’s Report; And Related Amendments to PCAOB Standards. Moving to the operational excellence objective, Hornberger reported on new services for members. TSCPA has partnered with Radiate360 to offer CPAs an innovative way to expand their reach and connect clients online with this all-inclusive platform.

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Allyson Baumeister, CPA-Fort Worth, and Johnny Baines, CPA-Dallas

Treasurer Jeannette Smith, CPA-Rio Grande Valley, and Treasurer-elect Jim Oliver, CPASan Antonio

It allows them to create and manage a mobile-optimized website, connect and maintain their social media presence, promote their services, and much more. Radiate360 also has analytics tools to measure website traffic, social media reach and campaign success. TSCPA has partnered with Pearl Insurance to provide the new TSCPA Member Insurance Program. Members will be able to choose from different coverage levels and benefit choices to find a plan that’s right for them. Society membership allows exclusive access to a variety of group insurance plans such as life insurance, disability income insurance, long-term care, and more. Recruitment and retention are important to keep TSCPA’s numbers strong and enable the Society to speak with a powerful voice. The current recruitment campaign focuses on the responsibility of individuals to protect their profession. Several hundred have joined TSCPA and its chapters in recent months. To attract students to the profession, there are numerous Accounting Career Education (ACE) projects growing the next generation of CPAs.

GLOBAL MEMBERSHIP, DEMOGRAPHIC AND DIVERSITY ISSUES

Executive Director/CEO John Sharbaugh, CAE, spotlighted trends that could affect TSCPA and the profession as a whole. They include time pressures, value expectations, member market structure, generational differences, competition, and technology. A study conducted by the American Society of Association Executives, titled “Decision to Join,” provides insights into how individuals determine value in an association and why they choose to belong. The primary areas of inquiry were attitudes toward associations in general and attitudes toward the sponsor association. Survey results indicate that respondents’ perception of value from their association and the likelihood to recommend membership to others increases with their level of involvement. Respondents expressed the personal benefits of joining an association: access to the most up-to-date information available; professional development/educational program offerings; opportunities to network with other professionals; the opportunity for career information and employment opportunities; and access to products, services and suppliers. Sharbaugh then discussed some of the demographic issues

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Corpus Christi Chapter members David Morales, CPA; Paul Damerow, CPA; Susie Sullivan, CPA; Diane DeCou, CPA; Amy Twardowski, CPA; and Jerry Spence, CPA

affecting membership. The U.S. is becoming a more racially diverse country, and Texas is already there. Progress has been made regarding the percentage of Hispanic new accounting bachelor’s and master’s degrees graduates hired by CPA firms and the effort should continue. There has been evidence that Generation X and Y workers are behaviorally different than Baby Boomers in their tendency to join associations. However, new generations are still likely to join if associations offer what they are looking for, but will do so at a later age. Then, he talked about older workers and strategies to retain them as members. “It’s important to offer the tangible and intangible benefits that young members of the profession want, and to utilize the talents of older members as mentors,” he explained.

‘LOW MAN ON THE TOTEMPOLE – HOW I BECAME A WHITE COLLAR CRIMINAL’ Former CPA Helen Sharkey shared the gripping details of her conviction for conspiracy to commit securities fraud and her time served in federal prison. Her message: listen to your gut. If you feel something is unethical, silence is not an option. She stressed that, if you don’t speak out, you can and will be held accountable – whether or not you are the decision maker. At age 28, she accepted her dream job at Dynegy Corporation as a consultant in deal structure. She was the lowest-level employee working on a $300 million structured finance transaction team called Project Alpha. The complex project was intended to reduce the gap between net income and operating cash flow resulting from the use of mark-to-market accounting and to derive a $79 million tax benefit. She explained that the existing accounting rules for special purpose entities were vague and a great deal of professional judgment was being used. Soon she began to see red flags, but doubted her instincts because of her relative inexperience. “Did I feel in my gut it was wrong? Absolutely. Did I think it was illegal? No way,” she said. After months of negotiation, the team flew to New York to

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Take Note close the transaction. The bank began to ask for things Dynegy had already established were not possible from an accounting perspective. During a crucial conference call with her supervisor, she was shocked when he agreed to a questionable concession demanded by the banks to complete the deal. Once the person she felt was the “voice of reason” caved into the bank, she “gave up on herself and stopped fighting for what she knew was right.” The transaction closed in 2001. By October of that year, the highly publicized implosion of Enron was making headlines. In April 2002, the Wall Street Journal published an article exposing Project Alpha. Soon after, the Securities and Exchange Commission got involved. In addition to not speaking up, Sharkey admits she made the mistake of not getting her own lawyer right away. Instead, she listened to Dynegy’s attorneys who told her that the government wasn’t interested in her because she was “the low man on the totem pole.” Meanwhile, Dynegy was building a case that Sharkey and her teammates acted without the knowledge of her supervisor, something she categorically denies. Dynegy and the bank would eventually settle with the SEC. Dynegy’s attempts to shield itself from indictment would open up a criminal investigation for employees working on the transaction. Sharkey and one of her colleagues eventually pled guilty. Another colleague was found guilty at trial and given the shocking sentence of 24 years, which was eventually overturned and reduced to six years. For three years, she lived with a pending sentence looming over her life. Before the time came to report to the maximum security federal prison in Houston, she met with a former Enron employee whom she credits with helping her prepare for what she might experience. Sharkey stressed to the audience that it was no “Club Fed.” During processing, she was strip-searched. In her cell, she slept in a cot with two other inmates because of overcrowding. She said she can still hear the slamming of the doors in the cellblock. She served her time and is now sharing her story as a caution to others. She said the two most important lessons she learned are: trust your instincts; and look out for yourself, because no one else will. “Loyalty means nothing when people are going to prison.” She finished her presentation by emphasizing the importance of doing the right thing, saying, “Raising a red flag might get you labeled a whistleblower or even get you fired. But think about which label you would prefer: whistleblower or felon?”

FINANCIAL ACCOUNTING FOUNDATION (FAF)

FAF trustee Mack Lawhon, CPA-Fort Worth, shared information about the foundation’s recent activities. FAF is responsible for the oversight, administration, and finances of both the Governmental Accounting Standards Board and FASB, its counterpart for the private sector. FAF is also responsible for selecting the members of both boards and their respective advisory councils.

He spotlighted some of the private company reporting issues currently on the landscape: • Convergence of International Financial Reporting Standards (IFRS) and GAAP; • IFRS for Small and Medium-sized Entities; • AICPA’s Financial Reporting Framework for SMEs; • Relevance of many standards; • Aggressive standard-setting agenda for FASB and the International Accounting Standards Board (IASB); • Private company GAAP in other countries; • Increased use of fair value accounting; • Financial crisis and aftermath; • Increasing cost to comply vs. benefit to users; • Current complexity in rules. As a follow up to his presentation at the January 2012 meeting of this group, he recapped events leading to FAF’s establishment of the Private Company Council (PCC) in May of that year. The PCC identifies, deliberates and votes on proposed alternatives within existing U.S. GAAP for private companies, and is the primary private company advisory body to FASB on active FASB projects. FAF’s Private Company Review Committee, which Lawhon chairs, has primary PCC oversight duties for the first three years. It is to hold PCC and FASB accountable for achieving goals. The plan is that, if all is working as intended at the end of the three years, the review committee will be folded into the Standard-Setting Process Oversight Committee. The PCC comprises four private company practitioners, three users of private company financial statements and three preparers. Members are appointed to a three-year term and may be reappointed for one additional two-year term. PCC members make a significant volunteer commitment and are not paid for their work on the council. When the PCC proposes GAAP alternatives, a two-thirds vote is required. FASB must act within 60 days. If it endorses, it does so by a simple majority. If it does not, it must provide written notification to the PCC indicating changes that would result in endorsement. The PCC is interacting with FASB on standards so complex that in-depth information is important. Billy Atkinson, CPA-Houston and chair of the PCC, provided an update on the council’s work. The Private Company DecisionMaking Framework is a tool for the PCC and FASB to use in identifying and providing alternatives within U.S. GAAP based on differential factors. It helps determine where guidance may differ between public and private companies. He emphasized that relevance for users, along with the reduction of cost and complexity, are dominant issues. He reported on FASB’s Definition of a Public Business Entity Project, which included input from the PCC. A few other projects include standards on interest rate swaps, goodwill, exception for VIE in common-control leasing, and combined instruments accounting for interest rate swaps. All PCC projects have involved recognition and measurement alternatives, as opposed to just disclosure.

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Atkinson stressed the importance of feedback. He invited CPAs to submit comment letters on proposals, send emails on issues affecting private company stakeholders, and watch for upcoming meetings. More information about PCC activities will be in future issues of Today’s CPA.

STRATEGIC PLANNING

Figure 1. TSCPA Leaders for 2014-15 Chairman-elect (Chairman in 2015-16) Allyson Baumeister (Fort Worth) Treasurer-elect (Treasurer in 2014-16) Roxie Samaniego (El Paso)

Strategic Planning Committee Chair Mike Young, CPAPanhandle, explained that TSCPA has begun developing its updated blueprint for success. A great deal of input is being gathered from leaders, volunteers, staff, chapters, and members at large. The process began with roundtable discussions and written comments at the Annual Meeting of Members in June 2013. Two statistically valid surveys were sent to a cross-section of members. One asked about issues such as challenges CPAs face in their work environment and keys to success for CPAs in the future. Questions are open-ended so that responses reflect what is truly on the minds of the members. Most of the queries are the same as those utilized in 2007 and 2010 surveys so that trends can be analyzed. The other survey was on CPE, asking about the ways respondents obtain their CPE, preferred course formats, preferred providers (and why), and who pays for courses. The means of gathering information also included strategy sessions for volunteers and staff, focused on areas such as CPE and membership. The sessions involved examination of trends, challenges and opportunities. All of the feedback was presented at a strategic planning retreat led by a professional facilitator. The group developed a draft set of goals, with specifics for achieving each. Their recommendations are being considered by the Strategic Planning Committee, which will develop a plan for approval by the Executive Board at its April meeting. The final version will then be communicated, and will take effect at the beginning of the upcoming fiscal year, June 1, 2014.

Secretary (One-year term – 2014-2015)

OTHER BUSINESS

Treasurer Jeannette Smith, CPA-Rio Grande Valley, presented a report on the current financial status of TSCPA and the CPE Foundation. The Treasurer-elect, Jim Oliver, CPA-San Antonio, presented future financial information. The Annual Meeting of the Accounting Education Foundation was conducted and trustees with terms beginning June 2014 were elected. The results of TSCPA’s electronic election for officers, Executive Board members, directors-at-large, and Nominating Committee positions were announced. Also, the Board of Directors voted to ratify the chairman-elect’s appointees. See Figure 1 for the names of 2014-15 leaders.

UPCOMING EVENTS The 2014 Annual Meeting of Members will be held in New Mexico at the Hilton Santa Fe Buffalo Thunder, June 27-28. The Sheraton Austin is the site for the next Midyear Board of Directors Meeting, Jan. 27-28, 2015. ■

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Melanie Geist (San Antonio) Executive Board (Three-year term – 2014-2017) Randy Crews (Rio Grande Valley)

Toni McBee Joyner (Brazos Valley)

Director-at-Large (Three-year term – 2013-2016) Blaise Bender (San Antonio)

Jason Freeman (Dallas)

Carol Collinsworth (Rio Grande Valley) Kelly Hein (Fort Worth) Phil Davis (Permian Basin)

Jennifer Hennessey (El Paso)

Sheri DelMage (Southeast Texas)

Royce Read (East Texas)

Michelle Downs (Central Texas)

Ben Simiskey (Houston)

Jennifer Fox (Brazos Valley)

Wendi Taber (Southeast Texas)

Lisa Ong (Dallas) was selected as a replacement Director-at-Large to fill a one-year remaining term (2014-2015) for Toni McBee Joyner, who is elected as a three-year Executive Board member and automatically serves as a board member. Tony Ross (Austin) was selected as a replacement Director-at-Large to fill a two-year remaining term (2014-2016) for Tracy Stewart, who resigned from the Board of Directors. Committee on Nominations (One-year term – 2014-2015) Susan Adams (Fort Worth)

James Larkin (Brazos Valley)

Koshy Alexander (East Texas)

Matt Malcom (Austin)

Kym Anderson (El Paso)

Martha Perez (San Antonio)

Leroy Bolt (Abilene)

Ben Simiskey (Houston)

Terri Hornberger (Dallas)

Sally Wolfe (Central Texas)

As immediate past chairman of TSCPA in 2014-2015, Willie Hornberger (Dallas) will automatically serve as the Nominating Committee Chair. AICPA Council – 3-Year Term (2014- 2017) The following names will be submitted to the AICPA Nominating Committee as recommendations from Texas to serve on the AICPA Council: Willie Hornberger (Dallas)

Lei Testa (Fort Worth)

Ken Sibley (Dallas) AICPA Council – 1-Year Designee: Mark Lee (Houston) Chairman-elect Appointees ratified by vote of the Board of Directors at this meeting Executive Board (One-year term – 2014-2015): David Colmenero (Dallas)

Susan Spillios (Houston)

Billy Kelley (Permian Basin) Committee on Nominations

Fred Timmons (San Antonio)

Capitol Interest By Bob Owen, CPA | TSCPA Managing Director, Regulation and Legislation

A Peek at the 2015 Legislative Session Most legislators are concentrating on getting re-elected right now, with little thought given to what they might be asked to legislate in the 2015 session. By the time you read this, the primary elections will be over and those legislators not facing a run-off have a little breathing room before the final push for the general election in November. Many candidates who win the primary are actual or de facto winners already in the general election. In addition to those who have no November opponents, many primary winners have slam-dunk general elections because of gerrymandered districts. There probably aren’t any more than a dozen genuine general election legislative races. The real question answered by the primary elections this year is which Republican Party won. For the last several elections, the very conservative wing of the Republican Party has been consistently challenging less conservative incumbents, with some success. The challenges have been enough to cause some pundits to say Texas is now a three-party state. The 2012 elections saw less success by the very conservative candidates; this year, the less conservative party members are trying to strike back, challenging the more conservative incumbents. But while everyone is trying to get re-elected, or newly elected, Speaker Joe Straus and Lt. Gov. David Dewhurst have been issuing their Interim Charges to the House and Senate standing committees. These Interim Charges outline what most legislators will be working on (other than getting re-elected) between now and the 2015 legislative session. Straus is expected to win re-election as both a House member and Speaker, and his Interim Charges are seen as the best guide available at this early date on what the legislators will be dealing with in 2015. While Dewhurst’s future as lieutenant governor may be more tenuous, he also has outlined what he sees as important for the future. Both Straus and Dewhurst get substantial input from House members and senators before they issue the Interim Charges, so to some degree they reflect the interests and concerns of the current legislators, as well as their leaders. Education is prominent in the Interim Charges. Despite the major education legislation passed in 2013, there is still a school district lawsuit challenging the constitutionality of the public education funding system. If the district court judge rules against the state, the matter will finally move to the Texas Supreme Court. We seem to be at exactly the same place we were before the last session, except the district judge had actually announced that the system was unconstitutional back then, but never officially issued a ruling. He decided to hold off on the ruling until he saw what the Legislature would do during the session. He’s holding hearings again in light of education legislation in 2013. If he rules the system unconstitutional, the question

remains: Will the Supreme Court reach any decision before the 2015 legislative session? Regardless, we can expect more serious consideration of public education in 2015. There are several Interim Charges dealing with education, including reviewing funding formulas and capital needs of public schools. Funding formulas are at the heart of the current controversy. CPAs and tax lawyers will be interested in one charge to the House Ways and Means Committee, which is to “review the current process for resolving contested cases involving state taxes and fees. Examine the need for the creation of an alternative, independent review process to hear and decide such cases.” In other words, does Texas need a tax tribunal similar to the Federal Tax Court? We wrote more extensively about this issue in the last Capitol Interest article, but to recap: Tax cases are currently heard before administrative law judges (ALJ) that work in the State Office of Administrative Hearings (SOAH). The rulings of those judges are only recommendations to the state comptroller who gets the final say on the taxpayer’s claim. Since the comptroller is the one who disagreed with the taxpayer in the first place, some think we need a new system. Before Susan Combs was elected, the ALJs actually reported to the comptroller. Combs prevailed on the Legislature to move them to SOAH. Combs fulfilled a campaign promise, but some think the move was more form than substance. The law making that move expires in 2014, so the Sunset Advisory Commission (SAC) is charged with the responsibility of making a recommendation on the issue to the Legislature before 2015. It looks like SAC will have some oversight or input from Ways and Means on the issue. Of course, any ultimate legislation will likely go through that committee. The comptroller is also the object of another Interim Charge to “evaluate the actions of the comptroller’s office to increase transparency, accountability, and efficiency.” It seems like all the current comptroller candidates are promising the same thing, but legislators have probably heard those promises before.

Bob Owen, CPA, is TSCPA’s managing director of regulation and legislation. Contact him at bowen@tscpa.net.

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The issue of unused dedicated funds will still be around for the next session. There are billions of dollars of funds collected to be used for a specific purpose that have never had the funds appropriated for the stated purpose, so the money just accumulates and helps balance the budget. Last session, a law was passed prohibiting the total of such funds from growing. The House Appropriations Committee has been charged to “recommend additional methods to further reduce the reliance on dedicated accounts for budget certification purposes, and further examine ways to maximize the use of such accounts.” I have an idea – either spend the funds on their intended purposes or give them back to the taxpayers. The Legislature will also be looking at all the state’s retirement plans. While Texas public employee retirement plans are probably in better shape than many other states, there is still genuine concern about there being enough money long term to pay for promised benefits. They are also worried about the longterm viability of the retired employees’ health benefits. The House Committee on Business and Industry is charged with studying “the voluntary nature of workmen’s compensation in Texas and how it meets the needs of employees and employers.” That committee also is to “examine the issue of misclassifying employees as independent contractors on workers, employers, income tax withholding, and the unemployment insurance system. Review current statutory deterrents, including those required by HB 2015 (83R), and make recommendations for changes if necessary.” Some topics are perennial. The House Committee on Licensing and Administrative Procedures has been asked to “study appropriate methods to expand the right of individuals to challenge occupational licensing rules and regulations, and identify occupational licenses that may not be necessary for public safety or health.” While this charge is not aimed at professional licensing, TSCPA will be watching this study closely. During the last session, legislation was introduced that would have allowed non-licensed accountants more leverage to establish their credentials to do things that are now restricted to CPAs. That legislation was voted out of a House committee, but it never made it to the House floor for debate. Straus has asked the House Committee on State Affairs to “study Title 15 of the Election Code, which regulates political funds and campaigns, including requirements for financial reports by campaigns, candidates, officeholders, and political committees. Specifically, study what types of groups are exempt from reporting requirements in the Election Code and make recommendations on how to make the political process more transparent.” Last session, the Legislature passed a bill requiring more disclosure of funding sources by political entities only to have the bill vetoed by Gov. Perry. Maybe Straus thinks they can try again with a new governor in place in 2015. Other issues in Straus’ Interim Charges include: • Examine whether the frequency of property tax reappraisals strikes the proper balance between stability and Today’sCPA

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• •

• • • •

•

predictability in values for taxpayers and taxation at market value. Eradication of feral hogs. (You can already machine-gun them from a helicopter; maybe they will send in the drones!) Examine and evaluate economic development incentives to determine if the incentives are achieving the desired outcomes for which incentives were initially established – or, more simply stated: Do economic incentives work? Study the impact of credit card data theft and other credit or privacy information theft. Study the classification of 17-year-olds as adults in the criminal justice system of Texas. Consider an online voter registration system. Study the rules, laws, and regulations pertaining to the disposal of high-level radioactive waste in Texas and determine the potential economic impact of permitting a facility in Texas: Will Texas glow in the dark? Investigate the fatal explosion in West, Texas, in April 2013, for deficiencies in safety, risk management, and disaster planning by chemical facilities and state entities.

In addition to items laid out by Straus, Dewhurst has charged Senate committees with studying border security, personal privacy and data security. He has extensive charges related to protecting the personal privacy of Texas residents, with emphasis on warrantless surveillance and monitoring by the government, and minimizing the government’s collection of data on its citizens. DNA, gun owners’ privacy and health care information are specifically mentioned. Dewhurst also wants mandatory state agency reporting reviewed with the idea to eliminate unnecessary reporting; this sounds like a good one. There must be thousands, if not millions, of reports prepared by state agencies that do nothing but reduce forests and gather dust. Finally, the Senate State Affairs Committee is charged with investigating those entities that seem to patent everything in hopes of forcing businesses to pay royalties on what otherwise are considered common business practices. We have seen this concern at the federal level, and TSCPA and AICPA have been involved in trying to limit such so-called patents in the taxplanning area. Dewhurst’s charge identifies Patent Assertion Entities for investigation, with a view to limiting or eliminating “frivolous legal actions and unsubstantiated patent claims.” Perhaps most interesting about the Interim Charges are the two big items that are missing – water and transportation. The charges do include some instructions related to water and transportation, but they are styled as monitoring existing activities rather than suggesting major changes or resolutions to the state’s continuing water and road concerns. Straus mentioned that there would be more to come, so perhaps he is still working on these big issues. In the race for lieutenant governor, water and roads have been mentioned as important issues by all the candidates. You can expect water and roads to be a major concern for future Legislatures. ■ 21

Feature By Mohamed E. Bayou, Ph.D., Alan Reinstein, CPA, DBA, and Gerald H. Lander, CPA, CFE, DBA

OPPORTUNITY COSTS: A Tool to Make Better Business Decisions Opportunity cost is ubiquitous since all aspects of life involve opportunities. While some recent studies have examined this concept, the opportunity cost concept remains vague. Decision makers often ignore many opportunity costs, as well as sunk and implicit costs in making business decisions. THE CONCEPT OF OPPORTUNITY COST Economists and CPAs often view the opportunity cost concept differently, with the former defining it more broadly to encompass many types of costs, such as implicit costs not included by the latter. The real economic costs of production usually exceed the accounting costs of production because economic costs include both explicit accounting costs and opportunity or implicit costs; i.e., the value of the personal resources the owners of a business make available (their labor and capital). Thus, opportunity cost should be recognized and realized when calculating the real (economic) costs, including incremental costs. Companies may only maximize profits when they recognize their real costs. Austrian economists, particularly Ludwig Von Mises and the London School of Economics, developed the opportunity cost theory (Magni, 2009). Describing opportunity cost of an investment as the income foregone if decision makers invest their capital in different economic endeavors, Magni finds that opportunity cost is “income of a foregone opportunity.” Thus, it is a counterfactual income as opposed to the factual income received (or to be received) in actual facts” (Magni’s emphasis). Such opportunity costs include both financial and non-financial components; i.e., income forgone and loss of leisure time, respectively. Unlike CPAs, economists include all aspects of cost to derive opportunity costs. Kohler defines cost as “an economic sacrifice occurred in exchange to acquire an object.” While CPAs define cost of an object as a sacrifice of property obtained through past transactions, economists define cost of an object as a sacrifice of a potential property obtainable through a future transaction(s) of a foregone opportunity. Financial accounting does not record opportunity costs in financial records since doing so would violate the cost principle of goods not actually changing 22

“masters.” Accountants consider opportunity cost as a derived concept of the more general concept of cost, while economists consider all costs as opportunity costs. EXAMPLES OF APPLICATIONS OF ACCOUNTING AND ECONOMIC OPPORTUNITY COSTS Measuring labor costs for various market conditions and types of jobs should consider special labor market characteristics, including such direct factors as income taxes and unemployment insurance compensation, plus such indirect factors as job quality and the nature of the workers’ unemployment. Generally, CPAs would consider only the direct measurable costs, while economists would also consider the indirect factors. Next, resources used to assess healthcare costs should include economic opportunity costs that should consider difficult-to-measure indirect effects, such as costs of patients “waiting” while non-insured folks use scarce emergency rooms (Robinson, 1993), and which CPAs generally do not measure (Dawson, 1994). CPAs need comprehensive, disaggregated data at the individual patient level to measure opportunity costs, and allocating overhead and fixed costs is difficult given the problems of ascertaining the cause and effect relationships between resources and different users. Pharmaceutical product prices also often ignore opportunity costs since retail prices reflect the patent, government regulated profits, and sunk research and development costs of both successful and unsuccessful products. Thus, few studies estimate the opportunity costs of drugs, relying instead on prices. Also, valuing resources when no market exists, such as informal care or patient time costs, requires methods to derive what economists call “shadow prices” – the true social value Today’sCPA

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(or opportunity cost) of non-marketed resources, such as time and informal care. Health accountants and economists often disagree about proper techniques to measure the opportunity cost of time; for example, the best valuation of the opportunity cost of time for working age adults is the wage they are, or could be, making in paid work, varying according to whether the time lost involves lost work or leisure time, or the likelihood of being unemployed. Economists view opportunity costs as inapplicable in situations when decision makers must follow specific alternatives, as when Toyota follows a centralized approach to decision-making regarding major plant infrastructure. Business-unit managers lack autonomy to make such decisions since the decision is imposed in a top-down managerial hierarchy. Knight, an economist, explains that, “where there is no alternative to a given experience, no choice, there is no economic problem, and cost has no meaning.” But, as shown below, such uncontrollable costs can be meaningful for managerial performance purposes. Net opportunity cost is the difference between income of an alternative and the income of the best alternative (opportunity). Thus, when investors and other decision makers select the best economic alternative (investing capital in Project A or Project B), they should use the net opportunity cost (NOC) concept, as Equation 1 shows. NOCi = Best alternative’s income – Alternative i’s income (1) where, NOCi = Project i’s net opportunity cost. Hence, if project A has the highest income, B’s and A’s net opportunity costs are: NOCB = Income from project A – Income from project B = IA - IB NOCA = Income from project A – Income from project A = IA – IA = Zero Thus, selecting the best opportunity out of a set of mutually exclusive opportunities entails no net opportunity cost for an investment decision. Opportunity costs also relate to accepting specially ordered projects. For example, if I A= $10 and IB = $8, Project A’s net benefit = Income from Project A – Opportunity Cost (of not investing in IB) = $10 - $8 = $2. Also, Project B’s net benefit = IB – Opportunity Cost (of not investing in Project A) = $8 $10 = $(2). Now, if the firm were offered a special sales order, that would generate a $10 contribution margin [CM] (sales

less variable costs). Accepting the special order uses capacity available to generate $12 of CM for increased production of Product A. The net benefit of accepting the special sales order would thus equal the special order’s CM minus the related opportunity cost = $10 - $12 = ($2). In the short-term, the firm would reject the special order at the proffered price, but it should also consider such other factors as could it sell more units of Product A and the additional selling costs of doing so. The opportunity cost concept focuses on subjective “opportunities,” as decision makers have different opportunities and evaluate differently their attached values. Opportunities can be actual or potential. Actual opportunities are now available for decision makers. Potential opportunities are a product of imagination that may become relevant in such major decisions as committing to a long-term contract, changing one’s location of living, career and marital status. Opportunity cost can either be unconditioned or conditioned. UNCONDITIONED OPPORTUNITY COST When decision makers are not currently committed (no sunk cost), opportunity cost is described as “unconditioned.” However, when considering a choice of actions, three issues arise: (1) define all alternative opportunities; (2) measure the best of these alternative opportunities; and (3) measure the gains in selecting the best alternative opportunity instead of the selected choice – which is the opportunity cost (Alden, 2005, p.1). Ignoring the often hidden indirect costs of interest to economists, to illustrate, in purchasing real estate, a decision maker can select among four mutually exclusive alternatives, A-D (see Table 1). After calculating net benefits, the computed gross amounts of each alternative’s opportunity cost are $20,000, $30,000, $40,000 and $50,000 for alternatives A-D, respectively, as shown in Panels A of Table 1. Panel B shows the net opportunity cost of each alternative as the difference between the gross opportunity cost of the best alternative ($50,000 of alternative D as shown in Panel A) and the gross benefits of each alternative. Thus, the net opportunity cost of alternatives A-D are $30,000, $20,000, $10,000 and $0, respectively, which equal the net benefits from Panel A less Alternative D’s gross opportunity costs. continued on next page

Table 1 Unconditioned Opportunity Cost: An Illustration Panel A Gross benefits Costs (assumed equal for simplicity) Net benefits (gross opportunity cost)

Relevant Opportunities A

$90,000 70,000 $20,000

$100,000 70,000 $30,000

$110,000 70,000 $40,000

$120,000 70,000 $50,000

Panel B Best alternative’s net benefits Net benefits (gross opportunity cost) Net opportunity costs Today’sCPA

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Relevant Opportunities A

$50,000 20,000 $30,000

$50,000 30,000 $20,000

$50,000 40,000 $10,000

$50,000 50,000 $ 0 23

Opportunity Costs continued from page 23

Table 2 Conditioned Opportunity Cost: An Illustration Panel A

Relevant Opportunities

$90,000 (70,000) $20,000 (25,000)

(The Current Commitment) B $100,000 (70,000) $30,000 0*

$110,000 (70,000) $40,000 (25,000)

$120,000 (70,000) $50,000 (25,000)

($5,000)

$30,000

$15,000

$25,000

A Gross benefits Less: Costs (assumed equal for simplicity) Subtotal Less: Uncovered sunk cost of B Net benefits (gross opportunity cost)

*Alternative B is the current commitment, whose related sunk costs are not affected unless the decision makers switch to another alternative.

Panel B

Relevant Opportunities

A Best alternative’s net benefits Less: Net benefits Net opportunity costs

$30,000 (5,000) $35,000

Decision: Select Alternative D, which has the least amount of net opportunity cost. Table 1 quantifies all four alternatives’ benefits and costs; the best choice is real estate D, which has the least amount of net opportunity cost (i.e., $0). In short, when decision makers do not consider switching from a current existing commitment to a new alternative, opportunity cost is unconditioned and its application is straightforward, as illustrated in Table 1. CONDITIONED OPPORTUNITY COST The study next examined the effects of a “currently committed” decision maker, i.e., who has placed sunk costs into the project, who considers switching to a new alternative. The sunk cost of the current commitment “will not be altered as a result of a decision that will change business activity” (Henry and Burch, 1974). However, many decision makers consider cost recoverability. The organization behavior literature has many studies about escalation of failed commitments (Staw, 1981; Staw and Ross, 1988). Decision makers often are (overly) “committed” to unrecovered parts of sunk cost, and may make switching to a new alternative less preferable, as part of their personal learning curves. Given that the company is now committed to Project B, Table 2 illustrates this conditioned opportunity concept. Decision: Select Alternative B since it has the least amount of net opportunity cost; that is, maintain the status quo by not replacing real estate B. 24

(The Current Commitment) B $30,000 30,000 $ 0

$30,000 15,000 $15,000

$30,000 25,000 $5,000

Per Table 2, the best alternative is B, maintain the status quo and keep alternative B. The recent U.S. cash-for-clunker program illustrates the importance of sunk cost recovery in decision making. This government program paid about $4,500 to transfer ownership of each old car (clunker) to the government to stimulate automobile sales. CNN Money (March 9, 2010, p. 1) found that 30 percent of polled customers who used this program “had no intentions of buying a new car, but said they bought one because the government program was too good to pass up.” (So, basically, the program was a giveaway to the 70 percent who would have bought a car anyway.) While this credit reduced the cost of a new car, many customers also viewed the $4,500 as a sufficient recovery of the sunk cost invested in a clunker. This program temporarily strengthened but “cannibalized” future auto sales. When this program ended in August 2009, General Motors, Ford and Chrysler all reported that “September sales were down more than 30 percent from August” (The American, June 29, 2010). In summary, the essential question relevant to a decision making situation is not whether the past commitment can be reversed, but rather, it is how much is recoverable from the sunk cost in this commitment; that is, focus on cost recoverability rather than commitment reversibility. ISSUES IN USING OPPORTUNITY COST MODELS Transfer prices (TP) apply many different opportunity cost models that a number of company personnel often do not Today’sCPA

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recognize. Holstrum and Sauls denote four commonly used methods to calculate opportunity costs to set transfer prices, average variable cost, full cost, market price, and managementnegotiated prices. While the first three methods often fail to yield goal congruence, the fourth, negotiation, helps to measure the manager’s performance – a function of production and negotiation ability. However, a negotiated transfer price does not always lead to goal congruence, requiring central management to generate data independently and audit division-provided data. Holstrum and Sauls conclude that “when the transfer price is set by central management at the point at which the opportunity cost of the distributing division equals the opportunity cost of the manufacturing division, both divisions will be encouraged to produce that quantity that would be optimal for the firm. Also, Onsi discusses using opportunity costing with decentralized decision making and creating multi-product organizational profit centers, a potential problem in assessing divisional managers’ performance and incentive compensation based on profit. Assuming that MCa (marginal “variable” costs of Division A) = NMRb (net marginal revenue of Division B), the supplying profit center is not motivated to change the relative use of various factors of production in response to changing factor prices, since these favorable effects will pass over to the buying profit center. The profit center selling the final product will be motivated to manipulate its sales by delaying them into next year, if this year is especially profitable, or to increase its production inventory to capitalize more of its overhead, leading to increased profit if it is originally unfavorable. This affects the production of intermediate goods. The corporate level should thus monitor inventory levels (similar to Holstrum and Sauls’ approach) to help prevent this from occurring. Also, buying divisions could commit themselves to purchasing a certain volume. For a fairer profit distribution, profit center A should be given the profit foregone (motivational cost) from producing X1 and selling it to profit center B. Onsi factors in this “motivational cost” to reduce conflicts among profit centers, which Benke et al, call the “lost contribution margin,” also called the opportunity cost. Benke et al. propose a general approach to transfer pricing that shows companies how to determine a transfer price that will promote neoprofit (which is subject to ever changing constraints, business moves toward achieving the maximum profit), and enhanced performance evaluation. They also propose an opportunity cost general rule for transfer pricing, where the transfer price should equal the standard variable cost (SVC) plus the contribution margin per unit given up (CMGU) on the outside sale by the company when a segment sells internally. Thus, relevant costs equal out-of-pocket (i.e., variable) costs plus opportunity costs. The CMGU is the lost contribution (LCM), so the TP = SVC + LCM. The lost contribution margin (opportunity cost) is the difference between the external market price of the intermediate product and the SVC. Benke et al. suggest that smaller companies may need to apply the general

rule differently than their larger competitors, as when a small company views an oligopolistic market as being perfectly competitive. Next, Feldstein views the social opportunity cost (SOC) of a public investment project as the value to society of the next best alternative use to which the resources employed in the project could have derived, also discussing such rates as the Marginal Rate of Social Productivity of Private Investment, and the Weighted Average Rate of Return. He shows that the correct measure of the social opportunity cost of a public project is the discounted value of the consumption stream that would have occurred had the project not been undertaken. He discounts this present value at the social time preference (STP) rate, a normative rate reflecting the government’s evaluation of the relative desirability of consumption at different points in time. The estimated forgone consumption stream should reflect the source of funds, the productivity of private investment, and the effects of taxation and reinvestment. APPLYING ACCOUNTING OPPORTUNITY COSTS FOR BUSINESS DECISIONS FOCUS ON FOREGONE PROFITS Assume a company with a huge backlog of orders for a product that uses a critical machine that generates revenues of $1,000 per hour, but incurs incremental costs and expenses of $400, deriving $600 per hour of contribution margin. Also assume that an employee failed to perform a routine maintenance task that caused the machine to shut down for 10 hours, and the repair bill (repairs and maintenance expense costs) to fix the machine was $800. But, the company also lost $6,000 (10 hours x $600 per hour) in operating or pre-tax income. This example derived $6,000 of opportunity cost of lost profits, ignoring the costs of lost or upset customers. However, if the machine were not critical to manufacturing the product or no backlog of orders arose, no foregone profits or opportunity costs would arise (Averkamp, 2011). TRANSFER PRICING EXAMPLES Drury states that the transfer price should equal the marginal (variable) cost to produce the transferred product or service, plus the opportunity cost of making the transfer. This point is illustrated by adapting Currie’s hypothetical Glass Co example. The illustration uses PlastiCo that has a Molten Plastic Division, whose summary of annual activities appear below. PlastiCo also has a Plastic Bottles Division that needs 20,000 tons of molten plastic per year to manufacture its bottles. This division currently buys all of its molten plastic from an external supplier for $210 per ton; it can continue using its current supplier, or buy its supplies from PlastiCo’s Molten Plastic Division. First, if the Molten Plastic Division could not increase its output above 80,000 tons per year, all products sold to the

Molten Plastic Division Output and sales (all to external customers) 80,000 tons

Selling price $240 per ton

Marginal cost (= variable cost) $130 per ton

Fixed costs $1,480,000 per year

continued on next page

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Opportunity Costs continued from page 25

Plastic Bottles Division would reduce external customer sales. Thus, its relevant cost to produce molten glass = $130 per ton (given), plus the opportunity cost to make the transfer (= lost contribution from foregoing the sale to the external customer = [$240 selling price - $130 marginal cost] = $110 per ton). Thus, the minimum transfer price = [Marginal cost incurred up to the point of transfer] + [Opportunity cost of making the transfer] = $130 + $110 = $240 per ton. The Molten Plastic Division also would not want to transfer its product for under $240, which would reduce the division’s profits. The Plastic Bottles Division will not pay more than $210. PlastiCo’s profits will be maximized by not transferring products. If the Molten Plastic Division has the capacity to increase its output above the current level of 80,000 tons per year, but incur no additional fixed costs and retain the $130 per ton of variable costs, and with no other external demand for its product, it could produce some extra molten glass for the Plastic Bottles Division without affecting its external customers. Its new REFERENCES Alden, Lori, 2005, “Opportunity Cost, A Primer,” retrieved October 8, 2012 from www.econoclass.com/opportunitycost.html, pp. 1-6. Averkamp, Harold, 2011, “Would You Please Help Me Understand Opportunity Cost?” Retrieved November 4, 2012, from http://blog. accountingcoach.com/opportunity-cost. The American, June 29, 2010, “Cash for Clunkers: A Retrospective,” retrieved October 8, 2012, from http://american.com/archive/2010/june-2010/ cash-for-clunkers-a-retrospective. Benke, Ralph L. Jr., James Don Edwards and Alton R. Wheelock, 1982, “Applying an Opportunity Cost General Rule for Transfer Pricing,” Management Accounting, June, pp. 43-51. Blocher, E. J., D. E. Stout, P. E. Juras and G. Cokins, Cost Management: A Strategic Emphasis, 6th ed. (NY: McGraw-Hill/Irwin, 2013). Burch, Earl E., and William R. Henry, 1974, “Opportunity and Incremental Cost: Attempt to Define in Systems Terms: A Comment,” The Accounting Review, January, pp. 118-123. Byrns, Ralph, 2011, “Accounting vs. Economic Costs,” Economics Interactive, retrieved October 8, 2012 from http://www.unc.edu/depts/econ/ byrns_web/Economicae/Essays/Actg_V_Econ.htm. CNN Money, March 9, 2010, “Cash for Clunkers, Better Than We Thought,” retrieved October 8, 2012 from http://money.cnn.com/2010/03/09/autos/ clunkers_analysis/index.htm. Currie, J. 2006. Transfer Pricing. Retrieved November 4, 2012 from http:// www.cpaireland.ie/UserFiles/File/students/Articles/Transfer_Pricing_Article_ by_John_Currie1.pdf. Dawson, D. 1994, “Costs and prices in the internal market: markets versus the NHS Management Executive guidelines.” York: Centre for Health Economics, University of York, 1994. Drury, C. 2004. Management and cost accounting (6th ed.). Thomson. Feldstein, Martin S., 1964, “Opportunity Cost Calculations in Cost-Benefit Analysis,” Public Finance, pp. 117-139.

calculations become, first, the relevant (variable) cost to produce molten glass = $130 per ton; no opportunity costs to make the transfer exists; and the minimum transfer price equals $130 per ton. The Molten Plastic Division manager can negotiate a price between $130 and $210 per ton to help maximize both divisions’ profits and yield goal congruence for PlastiCo. RECOMMENDATIONS CPAs, their employers, clients and other decision makers should consider the economic or accounting opportunity cost model to make major decisions, using Excel or other spreadsheet programs. While they both would use similar methodologies to consider sunk costs and to calculate opportunity costs, unlike CPAs, economists would consider the indirect costs of their decisions. They would state that after all, managerial decision making should consider all relevant economic costs. ■ Holstrum, G. L, and E. H. Sauls, 1973, “The Opportunity Cost Transfer Price,” Management Accounting (May): 29-33. Hoskin, Robert E., Spring 1983, “Opportunity Cost and Behavior,” Journal of Accounting Research, pp. 78-95. Jenkins, Glenn 1995. Economic Opportunity Cost Of Labor: A Synthesis, Development Discussion Papers 1995-02, JDI Executive Programs. Knight, Frank Hyneman 1935, The Ricardian Theory of Production and Distribution (Chicago: University of Chicago Press) Kohler, E. L. 1963. “Why Not Retain Historical Cost?” Journal of Accountancy, 116(4), 35-41. Koopmanschapp, MA, and F. H. Rutten 1996, “A practical guide for calculating indirect costs of disease.” Pharmacoeconomics. 1996; 10: 460–466. Magni, C.A. 2009. “Splitting up value: a critical review of residual income theories.” European Journal of Operational Research (198, 1): 1-22. McRae, T.W., 1970, “Opportunity and Incremental Costs: An Attempt to Define in Systems Terms,” The Accounting Review, April, Vol. 45, No. 2, pp. 315-321. McRae, T.W., 1974, “A Further Note on the Definition of Incremental and Opportunity Cost,” The Accounting Review, January, Vol. 49. No. 1, pp. 124125. Monden, Y., 1993. “Toyota Production System, An Integrated Approach to Just-In-Time.” Second Edition. Industrial Engineering and Management, Press Institute of Industrial Engineers. Onsi, Mohamed, “A Transfer Pricing System Based on Opportunity Cost,” July 1970, The Accounting Review, Vol. 45, No. 3, pp. 535-543. Staw, B. 1981. “The escalation of commitment to a course of action,” Academy of Management, 6 (October): 577-587. Ross, J. 1988. “Good money after bad,” Psychology Today, 22, 2 February: 30-33. Stiglitz, JE, 1986, Economics of the public sector. New York: Norton; 1986. Robinson R., 1993, Costs and cost-minimization analysis. BMJ.1993; 307: 726–728.

Mohamed E. Bayou, Ph.D., is Professor of Accounting in the College of Business, University of Michigan-Dearborn. He may be reached at mbayou@ umd.umich.edu. Alan Reinstein, CPA, DBA, is George R. Husband Professor of Accounting in the School of Business at Wayne State University. He may be reached at a.reinstein@wayne.edu. Gerald H. Lander, CPA, CFE, DBA, is Gregory, Sharer and Stuart Professor Emeritus at the University of South Florida-St. Petersburg. He may be reached at lander@mail.usf.edu. The authors would like to express appreciation to Dave Stout (Youngstown State University) and Phil Beaulieu (University of Calgary).

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Feature By Dr. Kamala Raghavan, Texas Southern University

The Potpourri of Professional Certifications in Accounting: What Do They Stand For? Accounting students get overwhelmed when faced with the bewildering array of possible career options and required certifications for each. Sometimes they face the time consuming and expensive choice of having to take additional courses to satisfy the educational requirements for the examinations. Licensing and educational requirements for the various certification options such as the ones listed below vary widely. Many specialty certifications are being added at a fast pace to satisfy the skills required by the increasing technology and globalization of the marketplace. This trend is quite in contrast to the tightly controlled world of accounting in earlier years. The Certified Public Accountant (CPA) law passed in New York in 1896 boosted the prestige and perception of technical competence to those who acquired it, and set them apart from others in the accounting profession. The certificate holders slowly branched out to other related areas, such as tax and cost accounting. In the early 1970s, Certified Management Accountant (CMA) and Certified Internal Auditor (CIA) certifications were added. Since then, the titles and certifications have proliferated to many sub-specialties, making the task of deciphering their value to accounting students quite difficult. With an accounting degree in hand, there are many career paths that the student can take: a career in public accounting in auditing, tax advice, consulting, fraud and risk examination; a career with a corporation or a government/non-profit organization in regulatory reporting, management and cost accounting, tax accounting, internal auditing, budgeting and forecasting, accounting systems or risk analytics; or a career as accounting faculty. Regardless of the path the student pursues, professional certifications are essential in an increasingly global and technologyoriented economy. Professional certification can increase the student’s chances for career advancement, enhance his/her reputation among colleagues and within the profession, and lead to higher salaries than non-certified peers. The dynamic nature of professional certifications in accounting makes it interesting and challenging for practitioners and academics to keep up with the requirements. This article reviews some of the leading accounting certifications and their requirements, while recognizing the dynamic nature of the certifications universe. Table 1 lists the professional organizations and their web links alphabetically. For a listing of accounting and related certifications offered by the professional organizations, please see the ‘Students’ section of TSCPA’s website at tscpa.org. ACCREDITED SENIOR APPRAISER (ASA) AND ACCREDITED MEMBER (AM) The American Society of Appraisers (ASA) confers the two designations of AM and ASA to individuals interested in the field of valuation and appraisal services. The applicant for the certificates must: Today’sCPA

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• Have a bachelor’s degree from an accredited college or university. • Pass a set of four principles of valuation courses. • Submit an appraisal report that will be reviewed and approved by the International Board of examiners. • Have a minimum of: • five years of full-time appraisal experience or equivalent for ASA designation; and • two years of full-time appraisal experience or equivalent to qualify for the AM designation. CERTIFIED BUSINESS APPRAISER (CBA) The Institute of Business Appraisers (IBA) confers the designation of Certified Business Appraiser (CBA) to denote competence in business appraisals. The applicant for the certificate must: • Have a four-year college degree from an accredited college or university or equivalent. • Successfully complete the Business Valuation and Certification Training Center (BVTC). • Pass the five-hour CBA written exam. • Successfully complete the Comprehensive Certified Business Appraiser Workshop (CCBAW). • Submit character references. • Submit two demonstration reports in accordance with the CBA Report writing checklist and the Applicant’s Handbook. CERTIFIED PUBLIC ACCOUNTANT (CPA) The CPA certification is the most sought after certification by accounting professionals, and is administered by the American Institute of Certified Public Accountants (AICPA). It is a required credential to practice public accounting. To be able to obtain the certificate, the applicant must: • Obtain an application “of intent” from the board of accountancy in the state where the certification is desired. • Meet the educational requirements specified by the state of choice to sit for the Uniform CPA examination. A few states require only a bachelor’s degree with a concentration in accounting, while most others have adopted a 150-semester hour educational requirement. The state board of accountancy continued on next page

The Potpourri of Professional Certifications Continued from page 27

or the Digest of State Accountancy Laws and State Board Regulations, published jointly by AICPA and the National Association of State Boards of Accountancy (NASBA) can help identify the requirements for the individual state. • Pass the Uniform CPA examination, which is computer-based and consists of four sections. • Meet the experience requirements – most jurisdictions require at least two years of public accounting experience, and successful completion of a course in professional ethics. • Meet the continuing professional education (CPE) requirements. • Comply with AICPA’s Code of Professional Conduct. CERTIFIED MANAGEMENT ACCOUNTANT (CMA) AND CERTIFIED IN FINANCIAL MANAGEMENT (CFM) The Institute of Certified Management Accountants (ICMA), an affiliate of the Institute of Management Accountants (IMA), started administering the Certified Management Accountant (CMA) certification program in 1972 to assess knowledge about management accounting. The Certified in Financial Management (CFM) certification program was started in 1996 to assess knowledge about financial management. The applicant for both certificates must: • Have a bachelor’s degree from an accredited college or university. • Have a CPA license or comparable international professional certification, or have scores in GMAT or GRE in the 50th percentile or higher. • Be a member of IMA. • Submit two character references. • Be employed or expecting to be employed in a position that meets the experience requirement. • Complete 30 hours of continuing professional education per year. • Comply with the IMA’s standards of ethical conduct. The computer-based exams consist of multiple-choice questions and are offered daily at Sylvan Technology Centers. Both CMA and CFM exams are divided into four parts. Parts 1, 3, and 4 are the same for both exams. Part 1: Economics, Finance and Management – covers micro and 28

macroeconomics, international business, working capital policy, long-term finance and capital structure, and organizational structure. Part 3: Management Reporting, Analysis and Behavioral Issues – covers cost measurement, planning, control, performance evaluation, and behavioral issues. Part 4: Decision Analysis and Information Systems – covers decision theory and operational decision analysis, investment decision analysis, quantitative methods for decisional analysis, information systems and management controls. Part 2 of the CMA and CFM examinations differ in subject content as follows. Part 2 of the CMA exam: Financial Accounting and Reporting covers development of accounting standards; preparation, interpretation and analysis of financial statements; and external auditing. Part 2 of the CFM exam: Corporate Financial Management covers usage of financial statements, corporate financial management, risk management, external financial environments and accounting standard setting. Certificate holders in either exam can pass part 2 of the other exam to receive credit for both exams. If a candidate does not pass any part, it can be attempted again after a 90-day waiting period. Credit for completed parts can be retained indefinitely as long as the applicant is a member of IMA, completes 20 hours of continuing professional education per year, and takes at least one exam part per year. The experience requirements for both CMA and CFM certifications consist of two continuous years of professional experience in management accounting and/or financial management prior to or within seven years of passing the exam. Professional experience is defined as employment where the certificate holder uses principles of management accounting or financial management (e.g., financial analysis, budget preparation, management consulting). CERTIFIED INTERNAL AUDITOR (CIA) The Institute of Internal Auditors (IIA) started administering the Certified Internal Auditor (CIA) certification program in 1974 to test knowledge of auditing standards and practices, and the ability to identify audit risks, examine alternative remedies and prescribe the best initiatives to control risks. The applicant for CIA certification must:

• Hold a bachelor’s degree or its equivalent from an accredited institution. • Satisfy the professional experience requirements – two years of internal auditing experience or the equivalent (experience in areas such as external auditing, quality assurance or internal control). A graduate degree or professional business experience (accounting, law or finance) can substitute for one year of experience. • Meet continuing professional development (CPD) requirements. The CPD requirement for CIAs performing internal audit functions is 80 hours of CPD every two years, while CIAs who are not performing internal audit functions are required to complete 40 hours of CPD every two years. The CIA exam consists of four parts with multiple-choice questions in each part. Part I, Internal Auditing Process, covers auditing, professionalism and fraud; Part II, Internal Audit Skills, covers audit evidence evaluation, data gathering and sampling techniques; Part III, Management Control and Information Technology, covers operations management, as well as management control and information technology; Part IV, The Audit Environment, covers financial and managerial accounting, finance and the regulatory environment. CPA, CMA or CISA certificate holders can receive credit for Part IV of the CIA exam. CERTIFICATION IN CONTROL SELFASSESSMENT (CCSA) The Institute of Internal Auditors (IIA) administers the Certification in Control Self-Assessment (CCSA). To earn the certification, applicants must: • Pass the CCSA computer-based exam consisting of objective questions. The exam will deal with control selfassessment fundamentals, process and integration, risk, controls and business objectives. • Hold a bachelor’s or equivalent degree. A two-year associate’s degree plus three years of general business experience may be substituted for a bachelor’s degree. • Have one year of control-related business experience such as auditing, quality assurance or risk management. Today’sCPA

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• Maintain their knowledge and stay abreast of developments in control self-assessment. CERTIFIED INFORMATION SYSTEMS AUDITOR (CISA) Certified Information Systems Auditor (CISA) certification is administered by the Information Systems Audit and Control Association, a professional association dedicated to the audit control and security of information systems. Applicants for the CISA designation must: • Pass the CISA examination. • Meet work experience of minimum five years in information systems auditing, control or security. The experience must have been gained within 10 years preceding the application for certification or within five years after passing the CISA exam. • Abide by the CISA’s Code of Professional Ethics. • Obtain 120 hours of continuing education credits in a three-year period. The CISA examination consists of five sections or “domains.” Domain 1 tests the candidate’s knowledge of information systems (IS) audit standards, statements and control practices; Domain 2 tests the ability to analyze and evaluate IS strategies, policies and procedures; Domain 3 deals with IS processes, hardware and software platforms, network and telecommunications infrastructure, and utilization of IS resources; Domain 4 deals with data validation, processing controls and the IS audit testing process; Domain 5 deals with IS development, acquisition and maintenance. CERTIFIED FINANCIAL FORENSICS ACCOUNTANT (CFF) AND ACCREDITED IN BUSINESS VALUATION (ABV) CFF and ABV certifications are offered by the Forensic and Valuation Services (FVS) section of AICPA as specialty designations for CPAs involved in forensics, valuation and related consulting. To be able to obtain the certificate, the applicant must: • Have a CPA certificate in good standing. • Successfully complete the CFF or ABV examinations. • Meet the continuing education requirements. Both exams are computer based and consist of discrete multiple choice and case study questions. The CFF exam has three major areas: Professional responsibilities and practice management, fundamental Today’sCPA

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forensic knowledge (e.g., laws, courts and dispute resolution, reporting, experts and testimony), and specialized forensic knowledge (e.g., bankruptcy, insolvency and reorganization, computer forensic analysis). The CFF certification requires the applicant to meet the professional experience requirements. The ABV exam has three major areas: Qualitative and quantitative analysis (e.g., economic and industry data analysis, etc.), valuation analysis (e.g., valuation approaches, discounts and premiums, reconciliations), related topics (e.g., engagement, litigation services, FLP, LLC, ESOPs). The ABV certification does not require specific training or experience. CERTIFIED FRAUD EXAMINER (CFE) Certified Fraud Examiner (CFE) is a professional certification awarded by the Association of Certified Fraud Examiners, an organization dedicated to fighting fraud and white-collar crime. CFEs gather evidence, take statements, write reports, and assist in investigating fraud in its varied forms. Most major corporations and government agencies have CFEs on staff. CFE certificate holders must: • Complete a bachelor’s degree from an accredited institution. • Have two or more years of professional experience in the detection or deterrence of fraud. The experience requirement can be met in several ways, including being an internal or external auditor, a corporate security director or consultant, or a federal, state or local law enforcement agent who investigates civil or criminal fraud or white-collar crime. • Pass the CFE examination with a score of at least 75 percent on each of the four sections. • Earn a minimum average of 20 hours of continuing professional education annually or 60 hours over three years. The computerized Uniform CFE exam is available upon request any time during the year and consists of objective questions equally divided among the four sections. The Fraudulent Financial Transactions section deals with types of fraudulent financial transactions; the Legal Elements of Fraud section tests knowledge of the legal ramifications of conducting a fraud examination, including rules of evidence, rights of the accused, and expert witness matters; the Fraud Investigation section tests the ability to conduct a fraud investigation, including interviewing, taking statements and report writing; and the Criminology and Ethics section tests

knowledge of criminological concepts and understanding of ethics. Credits for completed sections are retained for two years from the initial attempt, and will be eliminated after three attempts. CERTIFIED INFORMATION TECHNOLOGY PROFESSIONAL (CITP) CITP certification is administered by AICPA as a specialty designation for CPAs dealing with information technology. To be able to obtain the certificate, the applicant must: • Have a CPA certificate in good standing. • Successfully complete the CITP examination. • Meet the professional experience requirements. • Meet the continuing education requirements. The computer-based exam consists of multiple choice questions to test the following areas: Risk assessment (1015 percent), fraud considerations (5-10 percent), internal controls and information technology controls (25-30 percent), evaluate, test and report (15-20 percent), and information management and business intelligence (35-40 percent). CHARTERED FINANCIAL ANALYST (CFA) The Chartered Financial Analyst (CFA) program is a graduate level, self-study program offered by the CFA Institute to investment professionals aspiring to become portfolio managers and financial analysts. To become a CFA charter holder, the candidate must: • Have a bachelor’s degree (or equivalent) from an accredited institution. • Have four years of qualified work experience (or a combination of education and work experience acceptable to the CFA Institute). • Complete the CFA program by passing three six-hour examinations. • Become a member of the CFA Institute and a local CFA member society. • Adhere to the CFA Institute Code of Ethics and Standards of Professional Conduct. CHARTERED GLOBAL MANAGEMENT ACCOUNTANT (CGMA) CGMA certification is the newest certification administered by AICPA as a specialty designation for CPAs involved in management accounting. To obtain the certificate, the applicant must: continued on next page

The Potpourri of Professional Certifications Continued from page 29

• Have a CPA certificate in good standing. • Successfully complete the CGMA examination (starting in January 2015). • Meet the professional experience requirements (minimum of two years of financial or management accounting experience in business, industry or government; or two years of financial or management accounting experience plus one year in public accounting; or three years of financial or management accounting experience on a consulting basis; or three years in a management role focused on management and operation of an accounting firm). • Meet the continuing education requirements. IRS ENROLLED AGENT (EA) The EA certification is sponsored by the Internal Revenue Service (IRS) as a specialty designation for accountants who want to specialize in tax accounting and be able to represent their clients in front of IRS agents. To be able to obtain the certificate, the applicant must: • Obtain a Preparer Tax Identification Number (PTIN). • Successfully complete the computerbased EA examination consisting of three parts; Part 1: individual tax; Part 2: business tax; and Part 3: representation, practice and procedures. • Meet the professional experience requirements. • Meet the continuing education requirements.

PERSONAL FINANCIAL SPECIALIST (PFS) PFS certification administered by AICPA is a specialty designation for CPAs who are involved in financial planning. To be able to obtain the certificate, the applicant must: • Have a CPA certificate in good standing. • Successfully complete the PFS examination. • Meet the professional experience requirements. • Meet the continuing education requirements. The computer-based exam consists of multiple choice questions and scenario/case studies. The case study portion of the exam tests the candidate’s analytical reasoning skills and ability to apply financial planning theory and methodology in a comprehensive manner. The exam content consists of financial planning; income tax; insurance; investments; retirement and estate planning; employee benefits; charitable contribution planning; and other relevant topics. Candidates are allowed to take the exam only once during the calendar year. IMPLICATIONS FOR ACCOUNTING EDUCATORS Since accountants typically hold positions of trust with responsibilities to both internal and external users, possessing the technical knowledge to make reasonable judgments, communicate effectively, act with integrity and ethics, and demonstrate commitment to the public interest form the pillars of the framework for all professional accountants

regardless of the certifications they hold. Accounting information is central to the functioning of all organizations, including information dissemination to all stakeholders. In today’s rapidly changing business and technological environment, our capital markets cannot function without the essential flow of accurate, timely financial information provided by the professional accountants with necessary skills. While a degree in accounting from an accredited business school with rigorous coursework forms a solid foundation of accounting knowledge and prepares accounting students for the workplace, it is only the first step in pursuing their career goals. Professional certifications provide the special skills necessary for specific industries and personal career goals. Determining which professional certification is right for the student will depend upon his/her career goals, and worthy of careful analysis. Earning one of the accounting-related professional certifications is no easy task; however, earning and maintaining the certification can increase the chances for advancement and promotion, enhance reputation among colleagues and within the profession, and result in higher salaries than non-certified peers. The dynamic nature of professional certifications in accounting and increasing complexity of global capital markets make it critical for academic advisors to guide the students in planning their academic progress efficiently and effectively. ■

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TABLE 1. COMMON CERTIFICATIONS IN ACCOUNTING AND ORGANIZATIONAL LINKS Accredited Business Accountant (ABA) www.acatcredentials.org

Certified Public Finance Officer (CPFO) www.vgfoa.org

Accredited Valuation Analyst (AVA) www.nacva.org

Certified Financial Examiner Certified Government (CFE) Auditing Professional www.sofe.org (CGAP) www.theiia.org Certified in Financial Forensics (CFF) Certified Government www.aicpa.org Financial Manager (CGFM) www.agacgfm.org Certified Financial Services Auditor (CFSA) Certified Healthcare www.theiia.org Financial Professional (CHFP) Certified Financial Planner www.hfma.org (CFP) www.cfp.net Certified Information Systems Certified Forensic Auditor (CISA) Accountant (Cr.FA) www.isaca.org www.acfei.com Certified Information Certified Forensic Security Manager (CISM) Consultant (CFC) www.isaca.org www.acfei.com Certified Information Certified Forensic Financial Technology Professional Analyst (CFFA) (CITP) www.navca.com www.aicpa.org

Automated Examination Specialist (AES) www.sofe.org

Certified Fraud Deterrence Analyst (CFD) www.nacva.com

Certified Internal Auditor (CIA) www.theiia.org

Enrolled Agent (EA) www.naea.org

Certified Bank Auditor (CBA) www.bai.org

Certified Fraud Examiner (CFE) www.cfenet.com

Certified Management Accountant (CMA) www.imanet.org

Certified Business Appraiser (CBA) www.go-iba.org

Certified Fraud Specialist (CFS) www.acfsnet.org

Chartered Financial Analyst (CFA) www.aimr.org

Chartered Global Management Accountant (CGMA) www.cgma.org

Certified Merger and Acquisition Advisor (CM&AA) www.amaaonline.org

Accredited in Business Valuation (ABV) www.aicpa.org Accredited Financial Examiner (AFE) www.sofe.org Accredited Senior Appraiser (ASA) www.appraisers.org Accredited Tax Advisor (ATA) www.acatcredentials.org Accredited Tax Preparer (ATP) www.acatcredentials.org

REFERENCES Chiasson, Michael, Catherine Gaharan, and Shawn Mauldin. “A history of the development of AICPA’s specialty designation program,” The CPA Journal, 76, 1 (2006): 64-67. Department of the Treasury. Final Report of the Advisory Committee on the Auditing Profession to the U.S. Department of the Treasury, October 2008.

Certified Quality Auditor (CQA) www.asq.org Certified in Risk and Information Systems Control (CRISC) www.isaca.org Certified Risk Professional (CRP) www.bai.org Certified Treasury Professional (CTP) www.afponline.org Certified Valuation Analyst (CVA) www.nacva.org Elder Care Specialist (ECS) www.acatcredentials.org

Forensic Certified Public Accountant (FCPA) www.fcpas.org Personal Financial Specialist (PFS) www.aicpa.org

Certified Professional Environmental Auditor (CPEA) www.beac.org

Hutchison, Paul D., and Gary M. Fleischman. “Professional certification opportunities for accountants,” The CPA Journal, 73, 3 (2003): 48-51. American Accounting Association and American Institute of CPAs. The Pathways Commission: charting a national strategy for the next generation of accountants, July 2012. Turpin, Rick, John Alvis, and Nancy P. Tyler. “Professional Certifications in Accounting,” New Accountant, (2012).

Dr. Kamala Raghavan, CPA, CFF, CGMA, CFP, is a graduate faculty member at Texas Southern University in Houston, Texas.

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| MARCH/APRIL 2014

Feature By Mark Crowley, DBA, CPA, and MaryBeth Tobin, MSF, MST, CPA

Overstating Sales –

Creating Revenue Through the Consolidation Process If a company grows through acquisitions by buying companies with an equity interest of more than 50 percent but less than 100 percent, is there evidence of revenue creation through the consolidation process? According to the consolidation procedures of the United States Generally Accepted Accounting Principles (U.S. GAAP), companies report 100 percent of sales from the parent company, as well as 100 percent of sales from its subsidiaries, even if the parent does not have total ownership of these affiliates. on the parent company’s consolidated income statement in a line item labeled “non-controlling income.” This line item reports the amount of net income to which the parent company is not entitled. U.S. GAAP does not require a footnote disclosure to identify the non-controlling sales revenue associated with this noncontrolling income.

This article covers a study of 694 public companies with non-controlling income of at least $2 million. An estimate of overstated sales was obtained by dividing the non-controlling income by the consolidated company’s percentage of net income before non-controlling income. It can be inferred that these companies are taking advantage of the consolidation process and are overstating consolidated sales. CREATING REVENUE THROUGH CONSOLIDATION According to U.S. GAAP consolidation procedures, all sales from controlled 32

affiliates, whether wholly-owned (100 percent) or partially-owned (greater than 50 percent, but less than 100 percent), are added together with the parent company sales and reported as consolidated sales. During the consolidation process, the sales revenue from the entity that has a non-controlling interest (50 percent ownership or less) is not reported by that entity at all. Therefore, the parent company reports 100 percent of the sales from all subsidiaries in which it has a majority ownership interest. In doing so, the parent company picks up additional sales above the percentage it owns. The net income generated by these non-controlling sales is reported

METHODOLOGY To determine the extent of overstated sales revenue by consolidated companies, a COMPUSTAT report was run to identify a population of 3,000 consolidated companies that had noncontrolling interests reported in their 2011 fiscal year financial statements. Companies in this population with consolidated losses and/or noncontrolling income of under $2 million were eliminated from the analysis. The remaining sample consisted of 694 consolidated companies with at least $2 million in non-controlling income. The parent company’s consolidated sales, non-controlling income, and consolidated net income were obtained from the database. The percentage of net income before non-controlling income was calculated by adding non-controlling income back to consolidated net income and dividing the resulting net income before non-controlling income by total consolidated sales. An estimate of overstated sales was obtained by dividing the non-controlling income by the parent’s percentage of net income before non-controlling income. This grossing up process, although not exact, serves as a reasonable estimate of the overstated sales revenue reported by these 694 consolidated companies. Today’sCPA

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CONSOLIDATED FINANCIAL STATEMENT EXAMPLE Table 1 presents a simplified example depicting how a parent with one whollyowned subsidiary and one 80 percentowned subsidiary would prepare a set of consolidated financial statements. In this example, $20 million of sales attributable to the parent company’s non-controlling interest is included in the parent company’s consolidated sales of

$300 million. Although the conglomerate only owns 80 percent of subsidiary #2, the company takes full credit for 100 percent of the subsidiary’s sales. The $2 million non-controlling income generated by this $20 million of non-controlling sales is excluded from the parent’s consolidated net income. Therefore, the parent’s consolidated income statement reports the correct $28 million in net income solely attributable to the parent company. Despite reporting the correct amount of consolidated net income,

the parent company’s consolidated sales remain overstated by $20 million. This consolidation procedure follows U.S. GAAP. However, readers of consolidated financial statements should closely examine non-controlling interests before giving credit to the parent company for creating sales revenue without earning it. ESTIMATED NON-CONTROLLING SALES U.S. GAAP does not require a footnote disclosure to identify sales associated

Table 1. Example of Consolidated Sales: Parent and Two Subsidiaries (in Millions) Parent

Sub #1

Sub #2

Wholly Owned 80% Owned

20% NC Owned

Consolidated Sales

$20 (18) 2

$300 (270) 30

(2)

$28

Sales $100 $100 $80 Expenses (90) (90) (72) Net income 10 10 8 before non-controlling income Non-controlling 0 0 0 income Net income $10 $10 $8 Note: There were no intercompany sales in this example. Table 2: Detail of Estimated Overstated Sales (in Millions)

Sales

Consolidated Sales As reported by Conglomerate $444,948 100.00%

Expenses

(428,561)

96.32%

Net income before non-controlling income

16,387

3.68%

Non-controlling income

(688)

(.15%)

688

$15,699

3.53%

Net income

Non-Controlling Interest $0

Estimated Overstated Sales Attributable to Non-controlling $18,695*

*Estimate of overstated sales: Sales attributable to non-controlling interest ($688 ÷ 3.68% = $18,695).

continued on next page

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Overstating Sales Continued from page 33

Table 3: Descriptive Statistics (in Millions)

Consolidated sales Non-controlling income % of net income before non-controlling income Estimated overstated sales with non-controlling interest and therefore, it is necessary to calculate an estimate of non-controlling sales by grossing up the non-controlling income by the conglomerate’s percentage of net income before non-controlling income. In the example provided in Table 1, net income before non-controlling income is $30 million or 10 percent of the total consolidated sales of $300 million. The non-controlling income of $2 million is divided by 10 percent to arrive at $20 million, which represents the estimated amount of overstated sales reported by the conglomerate. This procedure was followed for all 694 consolidated companies examined in this study. LARGE RETAIL EXAMPLE Table 2 provides an example from the study of a large retail company that has consolidated sales of approximately $445 billion and non-controlling income of $688 million. Since the parent company’s percentage of net income before noncontrolling income is 3.68 percent, the overstated sales attributed to the

Mean

Max

Min

$21,173 147 9.3%

$470,171 7,794 10.4%

$37 2 8.8%

$1,580

$75,000

$23

parent can be estimated at $18.7 billion by dividing $688 million by 0.0368. Although $18.7 billion represents only a rounded 4 percent of the $445 billion in total sales generated by this consolidated company, $18.7 billion is still a material amount.

earnings quality, and the relationship between earnings quality and investment decisions.3 However, there is little written about sales quality and the likelihood that large conglomerates are actually creating revenue through the consolidation process.

RESULTS Table 3 summarizes the results of performing a similar analysis on each of the 694 consolidated companies included in the sample. The results indicate that average consolidated revenue for these 694 consolidated companies was $21.2 billion, and the average estimate of overstated sales was $1.58 billion or 7.5 percent of total sales. There is an abundance of literature written about the quality of financial statements. The majority of this literature is concerned with earnings quality and the cost of capital.1 It addresses the impact of earnings quality and income smoothing,2 the influence of the Internal Revenue Service (IRS) and taxes on

INDICATED RESULTS The results indicate that the average consolidated company included in this sample of 694 companies is overstating its sales revenue by $1.58 billion per year. The analysis provides evidence that large consolidated companies that have grown through mergers and acquisitions are actually creating revenue through the consolidation process. The results also suggest that this additional consolidated revenue may positively influence the market’s assessment of the company. ■

REFERENCES Apergis, N., Artikis, G., Eleftheriou, S., & Sorros, J. (2012). “Accounting information, the cost of capital and excess stock returns: The role of earnings quality-evidence from panel data.” International Business Research, 5(2), 123-136. doi:10.5539/ibr.v5n2p123 Chandra, U., Ro, B. (2008). “The Role of Revenue in Firm Valuation.” Accounting Horizons, 22(2), 199-222.

1. Apergis, N., Artikis, G., Eleftheriou, S., & Sorros, J., 2012 2. Hejazi, R., Ansari, Z., Sarikhani, M., & Ebrahimi, F., 2011 3. LI, F., 2011

Hejazi, R., Ansari, Z., Sarikhani, M., & Ebrahimi, F. (2011). “The impact of earnings quality and income smoothing on the performance of companies listed in Tehran stock exchange.” International Journal of Business & Social Science, 2(17), 193198. LI, F. (2011). “Earnings quality based on corporate investment decisions.” Journal of Accounting Research, 49(3), 721-752. doi:10.1111/j.1475-679X.2010.00397.x

Mark Crowley, DBA, CPA, is an Assistant Professor, Accounting and Finance department, Bridgewater State University, Bridgewater, MA. He may be contacted at mark.crowley@bridgew.edu. MaryBeth Tobin, MSF, MST, CPA is an Assistant

Professor, Accounting and Finance department, Bridgewater State University, Bridgewater, MA. She may be contacted at mtobin@bridgew.edu.

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Feature By Josef Rashty, CPA

Shareholders’ Earn-Outs and Earnings Management

Shareholders’ earn-outs in business combinations are a form of contingent considerations and represent an obligation of the acquirer to transfer additional assets or equity interests to the selling shareholders of the acquiree if certain future events occur or certain conditions are met. There is a subset of earn-outs, which stipulates that the acquirer promises to grant certain awards in the form of cash or equity to certain employees of the acquiree if certain performance objectives are achieved, or if certain conditions are met during the post-acquisition period. This type of earn-outs is referred to as compensation earn-outs.1 Companies may use shareholders’ earn-out arrangements (earn-outs) in business combinations to bridge the gap between what the acquirer and acquiree believe the business is worth based on future financial projections. The acquisition of companies that have significant growth projections or emerging technologies and products (e.g., high-technology and bio-technology companies) are examples where an earn-

out arrangement may be used. In these situations, an acquirer may negotiate some form of contingent consideration (earnout) that will be paid to the shareholders of the acquiree if certain objectives (i.e., certain level of revenue or profitability threshold) are achieved during the post-business combination period. continued on next page

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Shareholders’ Earn-Outs and Earnings Management Continued from page 35

This article aims to outline the accounting guidance and its implications during the post-business combination period for shareholders’ earn-out arrangements. It specifically addresses some of the conditions and circumstances that may lead to proper classification of earn-outs as either liabilities or equity, and discusses the impact of such classification in the postbusiness combination earnings. A comprehensive discussion of the criteria used for classification of awards as liabilities or equity is not within the scope of this article, but nevertheless the goal is to raise awareness of any potential earnings surprises during the post-business combination periods. ACCOUNTING FOR EARN-OUTS Shareholders’ earn-outs are usually in the form of contingent future cash payments (classified as liabilities), or warrants (classified as either liabilities or equity). It should be noted, however, that acquirers may commit to transfer non-cash properties or securities other than warrants in earnout arrangements. ASC 805, Business Combination, defines contingent consideration as an obligation of the acquirer to transfer additional assets, or equity interests, to the selling shareholders in the event that certain future events occur or conditions are met. ASC 805-10-55-24 states that arrangements for contingent payments to shareholders can be either part of the business combination or a separate transaction (in the form of postbusiness combination expense), depending on the nature of the arrangements. Understanding the underlying reasons why the acquisition agreement includes a provision for contingent payments, who initiated the arrangement, and when the parties entered into the arrangement may be helpful in assessing the nature of the arrangement. ASC 805-10-55-25 has a comprehensive list of indicators that companies should consider in evaluating the arrangements related to earn-outs and contingent payments in a business combination. Shareholder earn-outs are usually part of the business combination transactions. For example, an acquiree has developed a new technology and management believes that the revenues subsequent to acquisition would increase substantially as a result of that. The acquirer promises some earn-outs in the form of cash or equity to the shareholders of acquiree if the new product can generate a certain level of revenues subsequent to acquisition. This arrangement is part of the business combination transaction and the initial fair value of the earn-outs should be reflected in the purchase accounting entry. Furthermore, the acquirers need to determine if earnouts should be classified as equity or liability based on ASC 480, Distinguishing Liabilities from Equity, and ASC 815, Derivatives and Hedging. Cash earn-outs are typically classified as a liability, whereas equity earn-outs can be classified as either liabilities or equity. EARN-OUTS CLASSIFIED AS EQUITY Earn-outs classified as equity are measured initially at fair value on the acquisition date and are not typically re-measured subsequent to their initial recognition. ASC 805-30-35-1, Contingent Consideration, requires that the initial value recognized in equity contingent consideration arrangement 36

on the acquisition date should not be adjusted subsequent to acquisition, even if the fair value of the arrangement on the settlement date is different. EARN-OUTS CLASSIFIED AS LIABILITIES Earn-outs classified as a liability are recognized at fair value on the acquisition date, assuming fair value can be determined based on ASC 450, Contingencies (i.e., they are probable and estimable). Any changes in the valuation of liabilities are reflected in earnings subsequent to acquisition. The acquirer should also develop a systematic approach for subsequent measurement of earn-outs. Furthermore, if a liability initially fails to meet the probability criterion, but subsequently becomes probable, its total amount will be reflected in earnings. This is also true when the degree of probability-weighted average changes subsequent to initial measurement. The acquirer needs to consider a best estimate discounted cash flow to measure the fair value of the liability-classified earn-outs. CLASSIFICATION OF EQUITY AWARDS Classification of equity awards as liabilities or equity is a complex task. Acquirers prefer to classify equity awards as equity rather than liability since liability awards should be remeasured at the end of each period and the result is reflected in earnings. This section of the article deals with some of the criteria that distinguish equity awards from liability awards. The acquirer must first determine the appropriate classification of a contingent consideration based on ASC 480, which requires that an earn-out arrangement be classified as a liability if it meets any of the following conditions: • The contingent consideration is mandatorily redeemable. • The acquirer has an obligation to repurchase the contingent equity awards by transferring assets. • The acquirer has an unconditional obligation to issue a variable number of shares in lieu of contingent equity awards if certain event occurs. If a financial instrument cannot be classified as a liability under ASC 480, it does not necessarily imply that it should be classified as equity. The next step is to analyze the classification of the financial instrument based on the requirements of ASC 815. If the arrangement is within the scope of ASC 815, the financial instrument is a derivative and must be classified as a liability. The arrangement is a derivative if it meets the following conditions: • It has one or more underlyings and notional amounts. • It has an initial investment that is less by more than a nominal amount than the initial net investment that would be required to acquire the asset. • It can be settled net by means outside the contract such that it is readily convertible to cash (or its terms implicitly or explicitly require or permit net settlement). Many earn-out equity arrangements are within the scope of ASC 815 and should be classified as liabilities, but there are also some exceptions. The primary exception is ASC 81510-15-74, which requires that an arrangement must be both Today’sCPA

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indexed to an entity’s own share and has equity classification. ASC 815-4015 and 25, which are discussed in the following two paragraphs, clarify these two exceptions. ASC 815-40-15 requires that an exercise contingency arrangement should not be based on an observable market, other than the market for the entity’s own share, or an observable index, other than one measured solely by reference to the entity’s own operations (i.e., the price of gold or crude oil versus the revenues and EBITDA of the company). The guidance also requires that the arrangement must be “fixed-for-fixed,” which means that the arrangement must contain an explicit limit on the number of shares at a fixed exercise price. ASC 815-40-25 has a comprehensive list of a series of conditions that a contingent consideration arrangement should possess to be classified as equity. These conditions should be applied strictly, and their applications require a detailed knowledge and analysis of the arrangement and the underlying security laws. For example, the acquirer must have sufficient authorized and unissued shares available to settle an arrangement. Equity classification of awards is often precluded because the acquirer does not have sufficient authorized and unissued shares available to settle the contingent consideration. The acquirer needs to consider all outstanding and potentially dilutive instruments (such as stock compensation awards and convertible debt) to determine if it has sufficient authorized and unissued shares available. In summary, if an arrangement is not within the scope of ASC 480 and falls within the scope of ASC 815 and meets its criteria, it can be classified as equity at the acquisition date. VALUATION OF EQUITY EARNOUTS In a business combination, all items of consideration that an acquirer transfers must be measured and recognized at fair value at the acquisition date, including consideration that is transferred contingent upon some future specified event occurring (e.g., earn-outs). Equity shareholder awards are usually in the form of warrants, and due to the inherent uncertainty in equity shareholder earn-out arrangements, the fair value measurement of such awards is often complex and diverse in practice. The current view under ASC 820, Fair Today’sCPA

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Value Measurements, is that a liability must be measured based on the exit price of asset holder. The most challenging aspect of an equity earn-out valuation is its nonlinearity. For example, if the postbusiness combination revenue exceeds a certain level, the earn-out would be paid in full; otherwise, it would be nil. There is clearly not a linear relationship in this arrangement. Thus, due to the nonlinear nature of earn-out structure and the random nature of its underlying metric, it is necessary to consider multiple scenarios and the expected future distribution of different outcomes on revenues. As a result, valuation specialists usually use an option-pricing model or a second scenario-based model. A modified version of the Black-ScholesMerton option-pricing model could be used to value equity shareholders’ earn-outs. The valuation specialists usually tailor the shareholders’ earn-out valuation models to the unique factors that affect the underlying metric that triggers the payment (e.g., EBITDA, revenue, etc.). An acquirer generally should consider the full range of the outcomes for an earn-out arrangement and the probability of those outcomes to determine the fair value of equity awards.2 FAIR VALUE MEASUREMENT OF LIABILITY AWARDS Contingent considerations classified as a liability are covered under ASC 450, Contingencies. When a loss contingency exists as a result of earnout arrangements, the likelihood of its incurrence can range from probable (the future event or events are likely to occur) to remote (the chance of the future event or events occurring is slight). Topic 450 uses the terms probable, reasonably possible (the chance of the future event or events occurring is more than remote but less than likely), and remote to identify three areas within that range (ASC 450-20-25-1). The initial measurement of earn-outs classified as a liability may indirectly impact the acquirer’s post-business combination earnings. All contingent considerations are measured initially at fair value, but any changes in the initial fair value of contingent liabilities are recognized in earnings subsequently until the contingent consideration arrangement is settled. An entity should estimate the contingent loss and accrue it by a charge to earnings if both of the following conditions are met (ASC 450-20-25-2):

• It is probable that a liability had incurred at the date of the financial statements. • The amount of loss can be reasonably estimated. If an amount within a range of loss appears to be a better estimate than any other amount within the range, that amount shall be accrued. When no amount within the range is a better estimate than any other amount, the minimum amount in the range shall be accrued. Even though the minimum amount in the range is not necessarily the amount of loss that will ultimately be determined, it is not likely that the ultimate loss will be less than the minimum amount (ASC 450-20-30-1). The companies may also use a probability-weighted average to arrive at the best estimate for contingencies (the illustration in this article uses this approach to arrive at the most probable outcome). After the date of an entity’s financial statements, but before those financial statements are issued or are available to be issued, information may become available indicating that an additional or lower amount of cash earn-outs should have been accrued. If so, disclosure may be deemed necessary to keep the financial statements from being misleading (ASC 450-20-50-9). ILLUSTRATION The following two examples reflect the circumstances that lead to classification of equity awards as liabilities or equity. It depicts the circumstances that the classification of equity awards as a liability may have a more dilutive impact to post-business combination earnings. FIRST EXAMPLE Entity A (a publicly held company) acquires Entity S at the beginning of the first year. As part of the acquisition agreement, Entity A promises to pay shareholders of Entity S the following earn-outs if the following revenue goals are achieved at the end of the first year subsequent to acquisition. If the revenues of Entity S exceed $1 million for the first year subsequent to acquisition, Entity A will pay to the shareholders of Entity S $50,000 cash and 10,000 warrants (fair value at $10) to purchase an equivalent number of common shares of Entity A. continued on next page

Shareholders’ Earn-Outs and Earnings Management Continued from page 37

Table 1 Initial recording of earn-outs: Cash liabilities

$40,000

($50,000 times 80% probability-weighted average)

Warrant liabilities

$72,000

(10,000 awards times $9 valuation times 80%)

Cash liabilities

$70,000

($100,000 times 70% probability-weighted average)

Warrant liabilities

$189,000

(30,000 awards times $9 valuation times 70%)

Earnings impact for the first year subsequent to acquisition: (i) Cash earn-outs At the end of the year Less: initial liabilities recorded Earnings impact

$150,000 110,000 ($40,000 plus $70,000) $40,000

(ii) Warrants earn-outs At the end of the year Less: initial liabilities recorded Earnings impact

$440,000 (40,000 warrants at $11) 261,000 ($72,000 plus $189,000) $179,000

If, however, the revenues of Entity S exceed $2 million during the same period, Entity A will pay to the shareholders of Entity S an additional $100,000 cash and an additional 30,000 warrants (fair value at $10) to purchase an equivalent number of common shares of Entity A. Assumptions: Management of Entity A at the beginning of the year believes that the probability-weighted averages for Entity S to achieve $1 million and $2 million in revenues during the first year are 80 percent and 70 percent, respectively. However, the revenues of Entity S were $2.2 million for the first year. Furthermore, Entity A has sufficient authorized and unissued shares available to settle the arrangement. The BlackScholes-Merton valuation of warrants at the beginning of the first year was at $9 and at the end of the first year was at $11. The discount rate is assumed to be negligible. Analysis: (i) The arrangement appears to be within the scope of ASC 480 since Entity A is obligated to issue variable number of shares based on occurrence of certain event (in this case Entity 38

S revenue achievement). Thus, according to ASC 480, the earn-outs in this scenario must be classified as a liability. The analysis can be stopped at this point and does not need to go any further, but as it is discussed in the following paragraph, the arrangement fails equity classification in ASC 815 for a similar reason. (ii) The arrangement does not meet the exception requirement of ASC 815-10-15-74 for equity classification since the settlement amount of the contingent consideration does not incorporate fixed number shares even though it has a fixed exercise price (the arrangement is not “fixed-forfixed”). SECOND EXAMPLE Entity A (a publicly held company) acquires Entity S at the beginning of the first year. As part of the acquisition agreement, Entity A promises to pay shareholders of Entity S the following earn-outs if the following revenue goals are achieved at the end of the first and second years subsequent to acquisition. If the revenues of Entity S exceed $1 million revenues for the first year

subsequent to acquisition, Entity A will pay to the shareholders of Entity S $50,000 cash and 10,000 warrants (fair value at $10) to purchase an equivalent number of common shares. If the revenues of Entity S exceed $2.5 million for the second year, Entity A will pay to the shareholders of Entity S additional $100,000 cash and additional 30,000 warrants (fair value at $10) to purchase an equivalent number of common shares of Entity A. Assumptions: Management of Entity A at the beginning of the first year believes that the probability-weighted averages for Entity S to achieve $1 million and $2 million in revenues for the first and second years are 80 percent and 70 percent, respectively. Management did not change the probability-weighted average for the second year at the end of the first year. However, the revenues of Entity S were $2.2 million for the first year and $3.0 million for the second year. Furthermore, Entity A has sufficient authorized and unissued shares available to settle the arrangement. The discount rate is assumed to Today’sCPA

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Table 2 Initial recording of earn-outs: Cash liabilities Warrants equity Cash liabilities Warrants equity

$40,000 ($50,000 times 80% probability-weighted average) $100,000 (10,000 awards times $10) $70,000 ($100,000 times 70% probability weighted average) $300,000 (30,000 awards times $10)

Earnings impact for the first year subsequent to acquisition: Cash earn-outs At the end of the first year Less: initial liability recorded Earnings impact

$50,000 40,000 $10,000

Earnings impact for the second year subsequent to acquisition: Cash earn-outs: At the end of the second year $100,000 Less: initial liability recorded 70,000 Earnings impact $30,000 There is no required fair value adjustment for warrants recorded as equity. be negligible. The achievement of earn-outs in each arrangement is independent of the other. Analysis: The arrangement consists of two separate contracts that each would result in the delivery of fixed number of shares. Thus, the arrangement is not a liability under ASC 480 since the number of shares is not variable in each contract and does not meet the other two requirements. The arrangement meets the requirement of ASC 815, however, since (i) it has one underlying (revenues), (ii) it has an initial investment that is “less by more than a nominal amount (in this case nil) and (iii) the shares can be converted to cash (Entity A is a publicly traded company). But nevertheless the arrangement is subject to exception of ASC 815-10-15-74 for the following reasons: (i) it is based on an internal and operational index (i.e., revenues) rather than another observable market (e.g., gold or crude oil), and (ii) it

involves a fixed number of shares and a fixed exercise price (“fixed-forfixed” arrangement). Furthermore, Entity A has sufficient authorized and unissued shares available to settle the arrangement. Thus, the arrangement should be classified as equity (assuming that it meets all the other criteria of ASC 815-40-25). MANAGEMENT’S JUDGMENT Management exercises significant judgment in determining the probability of earn-out arrangements. Earn-outs could be in the form of cash or equity awards. The determination of equity versus liabilities awards also requires exercise of significant management judgment. Classification of equity awards as equity can potentially eliminate the earnings fluctuation during the postbusiness combination period. Strategic navigation of an acquisition through the accounting requirements to obtain equity treatment for earn-outs can be difficult. Liability earn-outs and their valuations at

the outset and in subsequent periods can create challenges for management and dilution in earnings. Estimating the fair value of the awards could be challenging, and regularly updating the fair value of the earn-outs classified as liabilities could result in earnings surprises during the postbusiness combination periods. Acquirers who do not focus on these matters when negotiating the terms and conditions of an acquisition may be surprised by the impact of earn-outs on their earnings and the unintended financial volatility during the postbusiness combination periods. ■ 1. Rashty, Josef. “Compensation Earn-Outs and Post-business Combination Earning Surprises,” Today’s CPA, March/April, 2012, pp. 38-43 www.josefrashty.com/uploads/2/8/9/2/2892636/ earn-out-pdf.pdf). 2. Zyla, Mark, et.al. “Valuing Contingent Consideration: Challenges and Solutions,” Journal of Accountancy, November 2011. pp. 28-33 www.journalofaccountancy.com/ Issues/2011/Nov/20114289.htm.

Josef Rashty, CPA, has held managerial positions with several publicly held technology companies in the Silicon Valley region of California. He is a member of the Texas Society of CPAs. He may be reached at jrashty@mail.sfsu.edu or j_rashty@yahoo.com.

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CPE Article By Deborah L. Lindberg and Deborah L. Seifert

SEC CLIMATE CHANGE RISK DISCLOSURES

Curriculum: Accounting and Auditing Level: Intermediate Designed For: Public Practice, Business and Industry Objectives: The objectives of this article are to inform auditors and management that companies must disclose risks related to climate change if such risks are significant to the organization. Key Topics: Key topics include the SEC Interpretative Guidelines for Climate Change Risk Disclosures, the sections of the 10-K in which climate change risk issues may need to be disclosed, and future considerations related to climate change disclosures. Prerequisites: None Advanced Preparation: None 40

On Feb. 2, 2010, the Securities and Exchange Commission (SEC) issued guidance regarding disclosures related to climate change risk, such as global warming, for publicly traded companies.1 There are numerous risks associated with climate change that could cost billions of dollars to contend with, mitigate and/or attempt to reverse.

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For example, the risk of natural disasters related to climate change include forest fires, hurricanes, tornados, floods and storm surges (Aon 2007). The primary climate change is global warming, which is associated with increasing concentrations of greenhouse gases in the atmosphere.2 In its press release announcing the interpretive guidance, the SEC noted that the “Commission’s interpretive releases do not create new legal requirements nor modify existing ones, but are intended to provide clarity and enhance consistency for public companies and their investors.”3 Thus, the SEC provided guidance on existing SEC disclosure requirements applicable to business or legal developments, including climate change issues. Further, the guidance issued by the SEC notes that as in other matters, publicly traded organizations are only required to disclose climate change risk if such changes are material, or expected to be material, to the organization’s assessment of risk.4 Under the SEC interpretive guidelines, companies may have to disclose climate change risk information in the following sections of the annual 10-K report: 1) the description of the business, 2) the summary of legal proceedings, 3) the discussion of risk factors, and/or 4) the Management Discussion and Analysis of Financial Condition and Results of Operations (MD&A). Disclosures that may be required in each of these categories are discussed in this article. BACKGROUND When registrants file required disclosure documents with the SEC, the requisite forms refer to disclosure requirements of Regulation S-K and Regulation S-X. In addition, Securities Act Rule 408 and Exchange Act Rule 12b-20 require registrants to disclose, in addition to the information expressly required by regulation, “such further material information, if any, as may be necessary to make the required statements, in light of the circumstances in which they are made, not misleading.”5 The interpretive guidance issued by the SEC gives specific advice as to when information related to climate change risk may need to be disclosed to prevent disclosures from being misleading. As with other disclosures, any disclosures made regarding risks associated with climate change can be limited to only material amounts and issues. CLIMATE CHANGE RISK DISCLOSURES While the SEC previously required its registrants to disclose the financial or legal impact of environmental challenges and issues, it never specifically cited climate change as presenting significant business risks.6 In the following paragraphs, we will discuss non-financial statement disclosure rules that may require disclosure related to climate change according to the interpretive guidance issued by the SEC; the majority of our comments are drawn from the SEC’s Guidance Regarding Disclosure Related to Climate Change issued on Feb. 8, 2010. DESCRIPTION OF BUSINESS Item 101 of Regulation S-K requires a registrant to describe its business, including its subsidiaries. Item 101 expressly requires disclosure regarding cost of complying with environmental laws. For example, registrants must disclose any material effects compliance with federal, state or local laws regarding protection of the environment may have on capital expenditures, earnings Today’sCPA

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and competitive position for the remainder of the registrant’s current fiscal year, its succeeding fiscal year, and for future periods, if deemed material. LEGAL PROCEEDINGS Item 103 of Regulation S-K requires a registrant to briefly describe any material pending legal proceedings, including any related to its property. More specifically, Instruction 5 to Item 103 provides several requirements that apply to disclosure of environmental litigation. If the registrant is involved in a legal proceeding regulating the discharge of materials into the environment or related to protecting the environment, the proceedings must be described if: 1. Material to the business or financial condition of the registrant; 2. They exceed 10 percent of the current assets of the registrant and its subsidiaries; or 3. A governmental authority is a party to such proceedings involving potential monetary sanctions, unless it is reasonably expected that such proceedings will result in no monetary sanctions or in sanctions of less than $100,000. RISK FACTORS Item 503(c) of Regulation S-K requires a registrant to provide a discussion of the most significant risk factors that make an investment in the registrant speculative or risky (other than risks that could apply to any issuer or any offering). If a disclosure is made as a result of this requirement, the risk factor disclosure should clearly state each risk and specify how the risk affects the registrant. MANAGEMENT DISCUSSION AND ANALYSIS Item 303 of Regulation S-K requires that management write “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” commonly referred to as MD&A. The MD&A is intended to satisfy three principal objectives: 1. Provide a narrative explanation of the financial statements as seen through the eyes of management; 2. Enhance the overall financial disclosures of the registrant and provide the context within which the financial information should be analyzed; and 3. Provide information about the quality and potential variability of earnings and cash flows, so that investors can ascertain the likelihood that past performance is indicative of future performance. Disclosures should be clear and communicate to shareholders management’s view of the company’s financial condition, with particular emphasis placed on the registrant’s prospects for the future. Disclosures should focus on material information. Accordingly, it may be appropriate for management to discuss risks, costs, etc. related to climate change or other environmental factors, since adequate disclosure of climate change risk can assist investors in knowing which companies are sustainable and worthy of investment. Table 1 summarizes the climate change risk disclosures that may be needed under SEC rules; continued on next page

CPE Article continued from page 41

Table 1 Climate Change Risk Disclosures Category of Disclosure

Climate Change Issues to be Disclosed

Description of Business

Disclose any material effects compliance with federal, state, or local laws regarding protection of the environment may have on capital expenditures, earnings, and competitive position.

Legal Proceedings

Legal proceedings must be described if: 1. Material to the business or financial condition of the registrant; 2. They exceed 10% of the current assets of the registrant and its subsidiaries; or 3. A governmental authority is a party to such proceedings involving potential monetary sanctions, unless it is reasonably expected that such proceeding will result in no monetary sanctions or in sanctions of less than $100,000.

Risk Factors

Provide a discussion of the most significant risk factors that make an investment in the registrant speculative or risky. If a disclosure is made as a result of this requirement, the risk factor disclosure should clearly state each risk and specify how the risk affects the registrant.

Management’s Discussion & Analysis

It may be appropriate for management to discuss risks, costs, etc. related to climate change or other environmental factors.

Source: Securities and Exchange Commission (SEC). 2010. Commission Guidance Regarding Disclosure Related to Climate Change. February 8. Available at www.sec.gov/rules/interp/2010/33-9106.pdf.

these disclosures cover a company’s business description, legal proceedings, risk factors, and management’s discussion and analysis. EXAMPLES OF CLIMATE RISK DISCLOSURES Table 2 provides excerpts from the 10K reports of several companies. These companies disclose climate change risk in various portions of the 10K such as the description of the business, legal proceedings, risk factors, and management discussion and analysis. For example, American West Resources disclosed the impact of climate change risk in the “Description of the Business” section of their 2011 10K report. American West discussed that carbon dioxide is a by-product of their process of burning coal and that carbon dioxide is a greenhouse gas. American West goes on to explain that the Kyoto Protocol, if ratified by the United States, could result in an increase in future regulation of greenhouse gases.7 Exxon Mobil Corporation provides climate change risk disclosure in the “legal proceedings” section of their 2011 10K filing. Exxon states that they have settled litigation in Louisiana regarding self-disclosed emissions in excess of air permit limits and a leak of propylene. They further discuss that they have agreed to an administrative order in Montana pertaining to the discharge of crude oil into the Yellowstone River.8 Principal Financial Group discloses climate change risk in the “risk factors” portion of their 2011 10K report. Principal Financial Group explains that while the increasing concentrations of carbon dioxide and other greenhouse gasses do not pose a significant threat to their business at this time, they could have a future impact. For example, Principal Financial Group may experience increased mortality and morbidity rates due to changes in temperature and air quality. Additionally, climate change may impact asset prices and the general economy and the government may move to increase regulation of carbon emissions. Lastly, 42

Principal Financial Group discusses that a natural disaster could impact the operation of their business and the safety of their employees.9 FedEx Corporation utilizes the Management Discussion and Analysis section of their 10K report, dated May 2012, to disclose how they might be affected by legal, regulatory or market responses to climate change. Specifically, FedEx discusses that they are now required to participate in the European Union Emissions Trading Scheme whereby they must submit emissions allowances, equal to the amount of carbon dioxide emitted, for flights to and from the European Union. They also explain that the United States could impose a comparable scheme, thus further increasing the cost structure of FedEx.10 FOREIGN PRIVATE ISSUERS While the SEC’s disclosure requirements for foreign private issuers are governed principally by Form 20-F, not Regulation S-K, the disclosure requirements are very similar. For instance, there are provisions of Form 20-F that may require a foreign private issuer to provide disclosure regarding material climate change matters, such as: • Material risks; • Material effects of government regulation on its business, including identification of the particular regulatory body; • Environmental issues that may affect the company’s utilization of its assets; • Management’s explanation of factors that have affected the company’s financial condition and results of operations for the historical periods covered by the financial statements; • Management’s assessment of factors and trends that are anticipated to have a material effect on the company’s continued on page 44

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Table 2 Corporate Excerpts of Climate Change Risk Disclosures Category of Disclosure

Corporate Excerpts Climate Change Risk Disclosures

Description of Business

American West Resources: “One by-product of burning coal is carbon dioxide, which is considered a greenhouse gas and is a major source of concern with respect to global warming…To date, the United States has refused to ratify the Kyoto Protocol. Although the targets vary from country to country, if the United States were to ratify the Kyoto Protocol, our nation would be required to reduce greenhouse gas emissions to 93% of 1990 levels from 2008 to 2012. Future regulation of greenhouse gases in the United States could occur pursuant to future U.S. treaty obligations, statutory or regulatory changes under the Clean Air Act, federal or state adoption of a greenhouse gas regulatory scheme, or otherwise.”

Legal Proceedings

Exxon Mobil Corporation: “…The Corporation has resolved a Consolidated Compliance Order & Notice of Potential Penalty issued by the Louisiana Department of Environmental Quality (LDEQ) to the Corporation’s Baton Rouge Resins Finishing Plant (BRFP) on October 16, 2008, relating to alleged exceedances of air permit limits for certain volatile organic compounds and hazardous air pollutants. BRFP had self-disclosed these emission results to the LDEQ and proposed a number of specific corrective action steps… …The Corporation has resolved issues raised by the LDEQ relating to a leak of propylene detected on January 10, 2010 at the Ethylene Purification Unit at the Corporation’s Baton Rouge, Louisiana chemical plant… …ExxonMobil Pipeline Company (EMPCo) entered into an agreed Administrative Order on Consent (AOC) with the Montana Department of Environmental Quality (MDEQ) to resolve civil and related liabilities under state environmental laws resulting from the July 1, 2011 discharge of crude oil into the Yellowstone River from EMPCo’s Silvertip Pipeline…”

Risk Factors

Principal Financial Group: “Changes in temperatures and air quality may adversely impact our mortality and morbidity rates. For example, increases in the level of pollution and airborne allergens may cause an increase in upper respiratory and cardiovascular diseases, leading to increased claims in our insurance businesses... Climate change may impact asset prices, as well as general economic conditions. For example, rising sea levels may lead to decreases in real estate values in coastal areas. Additionally, government policies to slow climate change (e.g., setting limits on carbon emissions) may have an adverse impact on sectors such as utilities, transportation and manufacturing. Changes in asset prices may impact the value of our fixed income, real estate and commercial mortgage investments… A natural disaster that affects one of our office locations could disrupt our operations and pose a threat to the safety of our employees…”

Management’s Discussion & Analysis

FedEx Corporation: “Concern over climate change, including the impact of global warming, has led to significant U.S. and international legislative and regulatory efforts to limit greenhouse gas (GHG) emissions, including our aircraft and diesel engine emissions. For example, during 2009, the European Commission approved the extension of the European Union Emissions Trading Scheme (ETS) for GHG emissions, to the airline industry. Under this decision, all FedEx Express flights to and from any airport in any member state of the European Union are now covered by the ETS requirements, and each year we are required to submit emission allowances in an amount equal to the carbon dioxide emissions from such flights. In addition, the U.S. Congress has, in the past, considered bills that would regulate GHG emissions, and some form of federal climate change legislation is possible in the future. Increased regulation regarding GHG emissions, especially aircraft or diesel engine emissions, could impose substantial costs on us, especially at FedEx Express.”

Sources: American West Resources, December 31, 2011 Annual Report Exxon Mobil Corporation, December 31, 2011 Annual Report Principal Financial Group, December 31, 2011 Annual Report FedEx Corporation, May 31, 2012 Annual Report

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CPE Article continued from page 43

financial condition and results of operations in future periods; and • Information on any legal or arbitration proceedings, which may have, or had in the past, significant effects on the company’s financial position or profitability. An example of recent climate disclosure under the Risk Factors section of the F-20 for BP states: “… Climate change and carbon pricing policies could result in higher costs and reduction in future revenue and strategic growth opportunities. Compliance with changes in laws, regulations and obligations relating to climate change could result in substantial capital expenditure, taxes, reduced profitability from change in operating costs, and revenue generation and strategic growth opportunities being impacted. Our commitment to the transition to a lower-carbon economy may create expectations for our activities, and the level or participation in alternative energies carries reputational, economic and technology risks.”11 THE FUTURE OF CLIMATE CHANGE RISK DISCLOSURES The SEC climate change risk disclosure guidance has been somewhat controversial since its 2010 implementation. Legislation to repeal the guidance was introduced in the 112th Congress but was not voted into law.12 However, the legislation could always be re-introduced at a later time. The criticisms of the SEC climate change risk disclosure guidance include that it is not extensive enough and does not include the disclosure of reputational harm that might result from climate change. Another criticism is that the climate change disclosures may do more harm than good, because most companies are disclosing information that may be uncertain and speculative in nature. Additionally, the SEC has carried out negligible enforcement with regard to the guidance, thus weakening corporate attention to the disclosures. It remains to be seen if Congress will appeal the guidance at a later date.13 AVAILABILITY OF INFORMATION The requirement that publicly-traded companies disclose material information to shareholders is based on the proposition that efficient, fair markets depend on the availability of information on corporate strategy, performance and policies so that investors can make rational investment decisions.14 If considered material, now such disclosures must specifically include risks related to climate changes, such as global warming. Thus, it could be argued that regulators are in effect assisting with sustainability efforts by requiring corporate disclosure of climate change risks, since the SEC requires that publicly traded organizations disclose climate change risk if such changes are material, or expected to be material, to the organization’s assessment of risk. Under the SEC guidelines, companies may have to disclose climate change risk information in the following sections of the annual 10-K report: 1) the description of the business, 2) the summary of legal proceedings, 3) the discussion of risk factors,

and/or 4) the Management Discussion and Analysis of Financial Condition and Results of Operations (MD&A) (SEC, 2010b). These SEC guidelines represent an improvement in corporate reporting requirements regarding risks associated with climate change. Adequate disclosure of climate change risk can assist investors in knowing which companies are sustainable and worthy of investment. However, some controversy does exist regarding the value of disclosures. The 112th Congress tried to repeal the guidance, but it was not voted into law. It is possible that Congress may try to repeal the SEC climate change risk guidance again at a later date. Acknowledgements: This article was funded and supported, in part, by a grant from the Katie School of Insurance & Financial Services at Illinois State University. ■ 1. Securities and Exchange Commission (SEC). 2010b. Commission Guidance Regarding Disclosure Related to Climate Change. February 8. Available at www.sec.gov/rules/interp/2010/33-9106.pdf. 2. Aon. 2007. Will Insurers Be Burned by the Climate Change Phenomenon? Available at www.aon.com/about-aon/intellectual-capital/attachments/riskservices/will_insurers_be_burned_by_the_climate_change_phenomenon.pdf. 3. Securities and Exchange Commission (SEC). 2010a. SEC Issues Interpretive Guidance on Disclosure Related to Business or Legal Developments Regarding Climate Change. January 27. Available at www.sec.gov/news/ press/2010/2010-15.htm. 4. Securities and Exchange Commission (SEC). 2010b. Commission Guidance Regarding Disclosure Related to Climate Change. February 8. Available at www.sec.gov/rules/interp/2010/33-9106.pdf. 5. Ibid. 6. Broder, J.M. 2010. “S.E.C. Adds Climate Risk to Disclosure List.” The New York Times. January 27. Available at http://www.nytimes.com/2010/01/28/ business/28sec.html. 7. American West Resources, December 31, 2011 Annual Report. Available at http://quote.morningstar.com/stock-filing/Annual-Report/2011/12/31/t. aspx?t=PINX:AWSR&ft=10-K&d=ad271afcd4b19ca47c45b01a48f9f5e4. 8. Exxon Mobil Corporation, December 31, 2011 Annual Report. Available at http://quote.morningstar.com/stock-filing/Annual-Report/2011/12/31/t. aspx?t=XNYS:XOM&ft=10-K&d=0d387df509056412c49bba5e3a44e097. 9. Principal Financial Group, December 31, 2011 Annual Report. Available at www. principal.com/investor/annual/2012/annualmeeting10k2011.pdf. 10. FedEx Corporation, May 31, 2012 Annual Report. Available at fedexannualreport2012.hwaxis.com/Files/FedEx_Annual_Report_2012.pdf. 11. BP, December 31, 2011 Annual Report and Form 20F. Available at www. bp.com/liveassets/bp_internet/globalbp/STAGING/global_assets/downloads/I/ BP_Annual_Report_and_Form_20F_2011.pdf. 12. SEC Climate Change Disclosure Guidance: An Overview and Congressional Concerns. May 24, 2012. Available at www.fas.org/sgp/crs/misc/R42544.pdf 13. SEC Climate Change Disclosure Guidance: An Overview and Congressional Concerns. May 24, 2012. Available at www.fas.org/sgp/crs/misc/R42544.pdf 14. Ceres. 2010. SEC: Companies Must Disclose Climate Risks, Opportunities. Available at www.ceres.org/Page.aspx?pid=1106.

Deborah L. Lindberg is a Professor in the Department of Accounting at Illinois State University in Normal, Illinois. She can be reached at dllindb@ilstu.edu. Deborah L. Seifert is an Associate Professor in the Department of Accounting at Illinois State University in Normal, Illinois. She can be reached at dseifer@ilstu.edu.

Today’sCPA

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CPE Quiz Today’s CPA offers the self-study exam below for readers to earn one hour of continuing professional education credit. The questions are based on technical information from the preceding article. Mail the completed test by April 30, 2014, to TSCPA for grading. If you score 70 or better, you will receive a certificate verifying you have earned one hour of CPE credit – granted as of the date the test arrived in the TSCPA office – in accordance with the rules of the Texas State Board of Public Accountancy (TSBPA). If you score below 70, you will receive a letter with your grade. The answers for this exam will be posted in the next issue of Today’s CPA. PARTICIPATION EVALUATION (Please check one.) 5=excellent 4=good 3=average 2=below average 1=poor 1. The authors’ knowledge of the subject is: 5__ 4__ 3__ 2__ 1__. 2. The comprehensiveness of the article is: 5__ 4__ 3__ 2__ 1__. 3. The article and exam were well suited to my background, education and experience: 5__ 4__ 3__ 2__ 1__. 4. My overall rating of this self-study exam is: 5__ 4__ 3__ 2__ 1__. 5. It took me___hours and___minutes to study the article and take the exam. Name _______________________________ Company/Firm________________________ Address (Where certificate should be mailed) ___________________________________ City/State/ZIP_________________________ Enclosed is my check for: ___ $15 (TSCPA member) ___ $20 (non-member) Please make checks payable to The Texas Society of CPAs. Signature____________________________

Notice: TSCPA has increased the price of the self-study exam to $15 (from $10).

SEC CLIMATE CHANGE RISK DISCLOSURES BY DEBORAH L. LINDBERG AND DEBORAH L. SEIFERT

1 A. B. C. D.

In what year did the SEC issue specific climate change risk guidance? 2009 2010 2011 2012

2 In which of the following sections of the 10K may corporations need to disclose climate change risk? A. Business Description B. Discussion of Risk Factors

C. Management Discussion and Analysis D. Any of the above

3 To disclose climate change risk under legal proceedings in the 10K, which of the following must be true? A. The climate change risk is material to the registrant C. The risk exceeds 5 percent of the current assets of B. A government agency is not party to the proceedings the registrant D. None of the above

4 Which corporation has their climate change risk disclosure in the “Description of Business” section of their 10K? A. Principal Financial Group B. Exxon Mobil

C. American West Resources D. FedEx Corporation

5 A corporate example of a climate change risk disclosed under the Management Discussion and Analysis in the 10K is which of the following? A. Exxon Mobil B. American West Resources

Climate change risk is included in the 10K as which of the following?

A. A forward looking statement B. A financial statement number

C. A disclosure D. An exhibit

Which of the following phenomena is the primary climate change risk issue?

A. Hurricanes B. Tornados

C. Principal Financial Group D. FedEx Corporation

C. Floods D. Global Warming

Which of the following is true regarding the climate change risk guidance?

A. The guidance is fully supported by Congress B. The guidance could be repealed by Congress

C. The guidance is fully supported by the business community D. The guidance is due to expire in 2014

9 What part of the 10K would you disclose whether the corporation is in compliance with federal, state and local laws regarding the protection of the environment? A. Legal Proceedings B. Discussion of Risk Factors

C. Description of Business D. Management Discussion and Analysis

TSCPA Membership No._______________ After completing the exam, please mail this page (photocopies accepted) along with your check to: Today’s CPA; Self-Study Exam: TSCPA CPE Foundation Inc.; 14651 Dallas Parkway, Suite 700; Dallas, Texas 75254-7408. TSBPA Registered Sponsor #260.

Principal Financial Group discloses climate change risk in which part of the 10K?

A. Management Discussion and Analysis B. Discussion of Risk Factors

C. Business Description D. Legal Proceedings

Answers to last issue’s self-study exam: 1. A 2. C 3. D 4. A 5. C 6. A 7. D 8. A 9. B 10. D Today’sCPA

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