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Newsletter – January 2018

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Implementations of the New Lease Standards Under the ASC 842

Mark Sloan, CPA, CFO Consulting Partners

On February 25, 2016, the FASB issued new guidelines under ASC Section 842 regarding the recognition and financial reporting of leases. The new standard will impact both lessees and lessors, with the most significant impact falling upon lessees. The standard is effective for years beginning after December 15, 2018 for public firms and December 15, 2019 for nonpublic firms.

This is one of the most comprehensive changes to accounting principles in many years, almost 250 pages long, and it will require major effort of firms to understand and implement its impact.

Due to the complexity of this pronouncement, this update will focus on the impact the new standard will have on lessees; a future update will focus on the impact on lessors.

In summary, the significant effect of this standard on lessees is as follows:

  1. Transactions which had been previously reflected as rent expense on the income statement will now require a right-of-use asset and a related lease liability being reflected on the balance sheet;
  2. Service arrangements for the use of assets over a period of years need to be evaluated and, if certain criteria is met, there needs to be a segregation of elements that are considered either lease components or non-lease components;
  3. Lease liabilities must be continually evaluated for the occurrence of significant events and revised accordingly, and;
  4. Criteria under previous guidance for determining a lease to be either an operating lease or a financing lease has been changed for the following:
    1. eliminating specific guidance regarding thresholds for determining economic life and fair value of leased assets;
    2. replacing such guidance with transaction specific judgement, and;
    3. adding a criteria that the leased asset has no alternative use to the lessor at the end of the lease term.

As a result of the new standard, it is expected that balance sheets will increase with over $1.5 trillion of additional assets and liabilities.

As a starting point, contracts for services must be reviewed, and both the lease and non-lease components must be identified and segregated. In its simplest terms, the standard states that if a contract conveys the right to control the use of identified property, plant or equipment (an identified asset) for a period of time in exchange for consideration, without significant control or substitution rights by the lessor, then a lease exists.

This will be among the most challenging aspect of the new standard. There must also be an analysis to determine whether there are multiple lease components which need to be accounted for separately and whether there are multiple non-lease components which should be accounted for under other appropriate GAAP. Also, there needs to be an ongoing evaluation of contracts to determine when an event occurs that may change the recognition or measurement of the lease, and that the entity distinguish whether there is a modification of an existing lease or the recognition of a new lease arrangement requiring separate accounting.

In addition to arrangements which clearly demonstrate a lessee/lessor relationship (such as the lease of office space), other arrangements must be carefully evaluated to determine if a lease exists. Such arrangements may include:

  • Advertising agreements
  • Service agreements
  • Transportation agreements
  • Construction agreements
  • Related party arrangements

It is important to identify lease and non-lease component of a service arrangement. The arrangement must be carefully evaluated for any asset that could be construed to be a lease in nature. One example is a data storage arrangement with a service provider. If the service contract includes the installation of a server on the location of the lessee, the lessor has no substantive substitution rights and the lessee derives most of the benefit of the asset over the lease term, then the server represents a lease component. An allocation of the rent payments need to be made between the server (the lease component) and the data storage (the non-lease component). The lease component must then be evaluated for either an operating lease or a finance lease and treated accordingly. The major difference between the two types will be that the income statement effect of the operating lease will be through rent expense while the income statement effect of the financing lease will be through interest expense and amortization expense.

Similar to previous guidance, leases meeting certain criteria will be considered a finance lease and there will need to be a right-of-use asset with a corresponding lease liability reflected on the balance sheet. The two amounts will be initially set up as the present value of the lease payments discounted at an appropriate interest rate (e.g., the lessee’s incremental borrowing rate).

A lease meeting any of the five following criteria will need to be classified as a finance lease:

  1. Ownership of the leased asset transfers at the end of the lease term;
  2. A bargain purchase option (i.e., one that is reasonably certain to be exercised) for the leased asset exists;
  3. The lease term, which does not commence near the end of the economic life of the leased asset, is primarily the remaining economic life of the leased asset;
  4. The sum of the present value of the lease payments and the residual value guarantees is equal to, or more than, substantially all of the fair value of the leased asset, and;
  5. The leased asset has no alternative use to the lessor at the end of the lease term because of its specialized nature.

What is important to bear in mind is the new pronouncement removes the 75% (for criteria #3) and 90% (for criteria #4) that former GAAP had provided as guidance and, instead, the lessee will need to take positions as to determining the remaining economic life or substantially all of the fair value of the leased asset. Also new is criteria #5 which needs to be taken into account in the determination of the character of the lease. The right-of-use asset will be amortized on a straight line basis (or any more systemic approach) over the term of the lease and the lease liability will be extinguished using the effective interest method. The income statement will reflect amortization expense for the reduction of the right-of -use asset and interest expense for the interest component of the lease payments.

If a lease arrangement is identified and considered not meeting the above criteria for a finance lease, then such operating lease will reflect, on the balance sheet, a right-of-use asset and a corresponding liability recorded at the present value of the rent payments, using an appropriate interest rate such as the lessee’s incremental borrowing rate. Both the amortization of right-of-use asset and the accreted interest on the lease liability will be reflected in rent expense on the income statement.
If an entity has both finance leases and operating leases, then the right-of-use asset and the lease liabilities must be presented separately for each type of lease.

If there are elements in the lease arrangement for step-up in rent payments, initial direct costs, payments of residual values, etc., such elements must be taken into account in calculating the right-of -use asset and corresponding liability.

Leases with terms of 12 months or less will be exempt from the standard as it relates to reflecting a balance sheet impact. Such leases will continue to be accounted for as under previous guidance, i.e., off balance sheet and footnote disclosure only.

As part of the transition process for the standard, there are practical expedients that an entity may elect, as a package and applied consistently, to all of its leases which commenced prior to the effective date of the standard:

  1. An entity need not reassess whether any expired or existing contracts are or contain leases;
  2. An entity need not reassess the lease classification (i.e., operating versus finance lease) made under previous GAAP for any expired or existing leases, and;
  3. An entity need not reassess initial direct costs for any existing leases.

If an entity foregoes these practical expedients, then it must apply the standard to all previous periods presented for which there are leases or contracts which contain lease and non-lease components.

On January 5, 2018, the FASB issued an Exposure Draft revising some of the provisions of ASC 842. The Board is requesting comments to this Exposure Draft no later than February 5, 2018.

The two issues on which the Board is seeking comments are as follows:

  1. Comparative reporting for initial adoption, and;
  2. Separating and allocating lease and non-lease components in a contract.

As it relates to comparative reporting for initial adoption, the Board has proposed recognizing a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. As it relates to separating and allocating lease and non-lease components in a contract, this proposed amendment would be applicable to lessors only. The amendment would provide lessors with a practical expedient that is currently available to lessees, which is to not separate non-lease components from related lease components for identified classes of underlying assets. This practical expedient would be available only upon meeting certain requirements, i.e., (i) the timing and pattern of revenue recognition for the non-lease component(s) and related lease components are the same, and (ii), the combined single lease component would be classified as an operating lease.

A subsequent newsletter will provide an update to the standard once the comment period has expired and the Board has finalized any revisions to ASC 842 regarding the aforementioned issues.

As can be seen from this brief summary, the new pronouncement on lease accounting will have a deep and profound effect on most entities. While the implementation date is still some time off, it would be prudent to begin to assess the effect this pronouncement will have on your financial statements. We here at CFO Consulting Partners have an extensive understanding of the new standard and stand ready to assist in evaluating and implementing this standard.

Newsletter – December 2017

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Physician Practices: The Future is Changing

John DeLorenzo, MBA, CFO Consulting Partners LLC

The United States possibly has the most complex healthcare system in the world. The American healthcare system regulates the industry at both the federal and state level. It is paid for by private health insurance as well as from the government under its Medicare and Medicaid programs. Healthcare services are provided by the private sector; however, the government also provides services directly through the Veterans Administration. All of this, in a population with disparate levels of wealthy and poor citizens, leads to highly chaotic distribution of care and a complex payment system.
While half of all Americans receive healthcare coverage through their employers, most plans are subject to regulations both federally and at the state level. Those Americans receiving healthcare coverage through Medicare and Medicaid, subject the provider to lower reimbursements. As a result, some providers are less willing to take on Medicare and Medicaid patients, leading to a shortage of providers for that patient base. Patients that are not covered by their employer or a federally provided healthcare program are required to seek private insurance. However, because of the Patient Practice and Affordable Care Act (PPACA), patients are generally provided less options then employer plans, and those options may restrict their choices regarding providers.
Because of a more recent development, a totally different method of reimbursement, from fee for service or volume payments, to outcome based reimbursements or Value Based Care (VBC) is being encouraged by both Centers for Medicare and Medicaid (CMS) and by private insurers. Essentially, fees for services under VBC are paid based on case outcome and the payment must be shared by all providers in the continuum. VBC reimbursement was originally introduced by the CMS. Both CMS and now private insurers are moving in the direction of value based reimbursement and providing incentives to providers to participate. What is essential to succeed in the VBC method of reimbursement lie in integration of providers and the ability to aggregate data.
Even prior to the movement to VBC, the PPACA is requiring all practitioners to utilize Electronic Medical Records, (EMR) which is costly in both software acquisition as well as implementation. While a burden to small practitioners and groups, EMR will ultimately allow groups to operate, integrate and bill more efficiently.
As new requirements continue to be heaped on single physician practices and small groups, they have been dwindling as more groups consolidate to gain scale and integration. Also, there is a significant trend toward physician groups selling their practices to hospitals as hospitals are a significant cog in the VBC wheel.
Sole practitioners and practice groups need to assess their situations and determine if they are positioned to continue independently or should they align with a network of providers or sell to a larger group or hospital.
Viability in the changing healthcare delivery model for practice groups will require a significant change in how a practice operates, will require investments in information technology, possibly require upgraded staffing as well as the development of relationships with other providers in the continuum.
CFO Consulting Partners healthcare practice is here to help you. We can assist you to access your current situation and help you create and implement a plan forward. We can also assist you should you decide to align with a network or sell or consolidate with another group or hospital.

 

Newsletter – November 2017

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Are You Ready for the New Revenue Recognition Standard?

Oliver Brooks, CPA, CFO Consulting Partners LLC

INTRODUCTION

On May 14, 2014 the FASB issued the standard ASC 606 Recognition of Revenue from Contracts with Customers. The FASB issued an Accounting Standards update to the Standard (ASU 2016 -10) in April 2016.

The implementation date for the standard is:

  • For public business entities, certain not-for-profit entities, and certain employee benefit plan
    • Reporting periods beginning after Dec 15, 2017
  • For all other entities
    • Reporting periods beginning after December 15, 2018

ASC 606 will have a major impact on the reporting of revenue for all entities, public and private that enter into contracts that promise the exchange of goods and services to their customers with a relatively minor impact on some costs associated with fulfillment of the contracts.

The standard is both complex and far reaching. Consequently, implementation is likely to require considerable effort and expertise.

Entities that plan to report GAAP financials would be well advised to consider moving quickly to initiate a thoughtful plan of action to comply with the standard.

 

OVERVIEW OF THE STANDARD

The following recaps the author’s view of the key guidance in the standard.

Performance obligations

The basic economic transaction is the contract between an entity and its customers. The standard address the accounting for the promises embodied in the contract, which it refers to as performance obligations.

The core principle of the standard is that an entity recognizes revenue when goods and services are delivered or fulfilled.

To achieve the core principle the standard promulgates a series of actions that an entity must undertake are:

  1. Identify the contract with the customer
  2. Identify the distinct performance obligation(s) in the contract
  3. Determine the transaction price
  4. Allocate the transaction price to the distinct performance obligations in the contract
  5. Recognize revenue when (or as) the entity satisfies the performance obligation(s)

Disclosures

ASC 606 requires considerably more disclosures about revenue. In general, the intent of the disclosures is to enable the reader to understand the nature and amount of the revenue being recognized and the uncertainty of the related cash flows.  More specifically the entity shall disclose:

  • Contracts
    • Disaggregation of revenue
    • Contract Balances
    • Performance Obligations
    • Transaction price allocated to remaining obligations

Other

The standard provides guidance on several other situations that can arise in the administration of contracts.  For example  (Not a complete recap)

  • Measurement of progress completion
  • Change in estimate
  • Right of return
  • Contract modification
  • Bill and hold arrangements
  • Cash and non cash consideration

 

IMPLEMENTATION

Given the complexity of this standard and its impact on revenue, it is incumbent on entities to have a well thought out implementation and transition plan. Some key issues that the plan should address include:

  • Financial: Determine the revenue streams that are impacted. Assess the need to review all customer contracts, possibly cataloging them and detailing their performance obligations.
    • Review the methodology in place for recognizing revenue and devise an intervention whether interim or final, systematic or manual, that brings revenue recognition into line with the standard
  • If the plan envisions significant manual effort be aware of the increased probability of errors and mitigate it with adequate quality control
  • Information System: Ascertain the need and /or feasibility of reconfiguring the ERP system to seamlessly produce financial information in compliance with the new standard
  • Organization: Communication to internal and external stakeholders. Determine the need for revised guidance to organization units that interface with customers or suppliers with regard to entering into, structuring of and reporting on contracts.
  • Transition: Decide on and prepare for full retrospective or modified retrospective presentation for financial statements presented after the implementation date. I.e.
    • Full retrospective: Apply the new standard as of the implementation date and, for the prior comparative periods, restate all contracts on the same basis
    • Modified retrospective: Apply the new standard as of the implementation date and, for the prior comparative periods, the data is not recast but instead apply a single adjustment to equity at the beginning of the initial year of application.

Companies are advised to begin the process early to ensure compliance. For complex revenue recognition issues, the company may want to consider outside professional resources to assist in the analysis.

More detailed information may be viewed here.

Newsletter – October 2017

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The CECL Approach, Part 2

Tom Van Lenten, CPA, CFO Consulting Partners LLC

This is the second in the CFO Consulting Partners series of articles analyzing the new FASB Standard on accounting for credit losses (ASU 2016-13). Click here for the first article in the series

It has been more than a year since the FASB issued ASU 2016-13 Click here for article . The new Standard is most commonly referred to as CECL, which is an acronym for “Current Expected Credit Losses”. The CECL standard requires an entity to recognize a forward-looking estimate of the expected credit losses in the Allowance for Loan and Lease Losses (ALLL), when an asset is booked. Current GAAP requires that the estimate of credit loss is based on incurred losses and banks typically historical losses as the basis for the calculation

CECL is one of the largest and most complex accounting standard implementations ever undertaken in the banking industry. Despite this, many banks have not begun urgent and focused execution of CECL implementation plans. Privately-held companies can see the long transition timeline (implementation is required at January 1. 2021 for non-SEC filers) as a reason for delay. However, public entities must react faster. They are required to include disclosures in their first SEC filings after issuance of ASC 2016-13 on June 16, 2016. The FASB has recently highlighted this disclosure requirement by issuing ACU 2017-3 in January 2017 which gives additional guidance for certain disclosures of standards that are issued but not yet implemented for SEC filers.

  • The basic requirements of ASU 2017-3 are:
    if an SEC filer does not know or cannot estimate the financial impact from adoption of a new ASU it should make a statement to that effect and should consider additional qualitative disclosures to assist the reader in assessing the impact that the standard will have
  • the ASU also requires additional qualitative disclosures to include a description of the effect of the accounting policies that the SEC filers expect to apply together with a comparison to their current accounting policies,
  • additionally, SEC filers should describe the status of the process to implement CECL and the significant implementation matters yet to be addressed.

In a recent informal survey of financial institutions by MST Click here for article covering the implementation of CECL, 5% of the respondents said that they have not yet begun preparation for CECL implementation, and 87% have only held internal discussions about CECL implementation. One experienced CFO has been quoted as saying, “the commonly followed CECL implementation strategy of waiting for other banks to report first is in fact dangerous.”

Considering the size and complexity of CECL implementation we agree that delay is a high-risk approach and that thoughtful planning now will yield significant benefits.

  • The major elements of CECL implementation include:
  • Analysis of CECL impacts on the bank,
  • Project management,
  • Credit modeling,
  • Accounting Policies,
  • Operations,
  • Systems integration [click here for a case study of a CFO CP systems integration].

In our next newsletter, we will discuss further considerations in CECL implementations.

Newsletter – June 2017

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Insurance Company Credit Rating Advisory Practice, Part 2

Marc Liebowitz, CFO Consulting Partners LLC

There are three primary drivers of insurance credit ratings:

  1. Risk adjusted capital levels
  2. Operating results
  3. Market profile which is the overall evaluation of strategies, products, underwriting strength and risk diversification.

In a previous article, we covered risk adjusted capitalization. Click here for the first article in the series. In this installment, we review how credit rating agencies evaluate operating results and market profile. Our focus is on the A.M. Best Company (AMB) and Kroll Bond Rating Agency (KBRA) methodologies as these agencies are most relevant to the mid-market insurance company ratings universe. The AMB and KBRA rating methodologies are available through their respective web sites:

A.M. Best’s Credit Rating Methodology
Global Insurer & Insurance Holding Company Rating Methodology

To measure the relative strength of a group’s operating results, analysts, develop a view of overall earnings power and compare those estimates to peer group averages and industry norms. The major components of this analysis are:

  • Comprehensive evaluation and trend analysis of financial outcomes, returns, and ratios
  • Development of multi-year projections and stress testing those forecasts
  • Review of key metrics for the consolidated organization and for individual business segments
  • Analysis of earnings by product and of investment portfolio earnings by asset type
  • Comparison of company specific results against peer group and industry-wide aggregates

Benchmarking comparisons are influential parts of the earnings analysis and management teams that demonstrate an understanding of key strategic and operational business elements which are apparent from this analysis are more likely to achieve their desired ratings outcome.

The market profile is a qualitative evaluation of a company’s spread of risk, revenue composition, and management strength. Given the qualitative nature of this analysis, management should provide a clear view of strategic plans and other elements which can provide a full picture of the company and how management approached the competitive landscape in its key markets.

A clear presentation of management’s plans to grow the company and improve operational efficiencies is essential to getting the appropriate rating for an organization. Sometimes there are areas where the goals of management and credit agencies are at odds. For example, a strategy to grow revenues and build the bottom line can be seen by the credit agency as a plan to add risk to the balance sheet. CFO Consulting Partners can work with the clients on how to best communicate the benefits of strategic actions and review strategies to mitigate the perceived risk.

Newsletter – May 2017

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Insurance Company Credit Rating Advisory Practice

CFO Consulting Partners has begun to work with insurance companies to help maximize a company’s rating potential. This article is the first of a two-part series which will discuss the credit rating process for insurance companies. Here we discuss how ratings firms look at capital levels, and how management can demonstrate effective capital management strategies. A subsequent article will review the roles of: operating results, market profile, and additional analytic considerations in the ratings process.

Marc Liebowitz, CFO Consulting Partners LLC

There are generally five Security and Exchange Commission (SEC) registered Nationally Recognized Statistical Rating Organizations (NRSRO), otherwise known as rating agencies, which follow the U.S. insurance industry: A.M. Best Company (AMB) and Kroll Bond Rating Agency (KBRA) are the primary providers of credit ratings to the mid-market segment of the industry. The three larger NRSROs: Fitch, Moody’s and Standard & Poor’s (S&P), tend to focus on the industry’s larger companies.

AMB and KRBA provide two types of ratings on insurance companies, debt and policy issuer strength ratings. Debt ratings are an indication of the insurer ability to meet their interest and principal obligations on specific bonds, a policy issuer strength rating considers the likelihood of a failure to honor a company’s insurance policy liabilities. For policy liability ratings AMB issues Financial Strength Ratings (FSR), and KBRA issues Insurance Financial Strength (IFSR) ratings. Insurance companies seek policy issuer strength ratings for several reasons, for example, ratings are required by insurance agents, by reinsurance brokers and companies, and to insure bonded construction projects. Also, ratings are utilized by boards and other stakeholders as a third-party evaluation of operations and capital adequacy.

There are three primary drivers of insurance credit ratings: risk adjusted capital levels, operating results, and market profile (the overall mix of products, underwriting strength, and risk diversification). These factors form the foundation of the rating and are quantified and evaluated relative to rated peer groups and to industry averages. Enterprise Risk Management (ERM) practices, management quality, and other qualitative factors are also considered and may raise or lower the rating.

AMB uses a proprietary capital model, Best Capital Adequacy Ratio (BCAR), details of AMB’s methodology can be reviewed here: Best’s Credit Rating. AMB is in the process of updating its BCAR model – the most significant change will be the incorporation of scenario modeling of an insurance company’s loss factors at various confidence levels. The revised BCAR model is currently open to public comment before it goes into production, likely prior to year-end 2017.

KRBA’s capital strength assessment uses the National Association of Insurance Commissioners (NAIC) Risk Based Capital (RBC) model.  KRBA details their capital adequacy approach within their rating methodology here: Global Insurer & Insurance Holding Company Rating Methodology

Rating agencies look at companies differently than management and other stakeholders – investors, employees, etc. Therefore, as part of any rating review or update management must be able speak to the agency’s perspective and clearly demonstrate management’s understanding of the company’s capital position, how it is managed through existing risk management programs, and how and why it will change going forward. Analysts expect management’s knowledge to extend beyond the results of the agencies capital modeling. Accordingly, management should present a forecast which considers the unique and proprietary aspects of the company’s strategy and operations. The ratings team will also want to discuss the programs in place to manage the company’s long-term solvency. All information presented by management will be distilled and compared to peer groups composed of comparable firms. Also, rating agency analysts cannot, due to SEC rules, provide guidance to companies on how to improve ratings.

To achieve rating upgrades, or to maintain a rating, management should plan to continuously improve risk management programs and strategies, create clear and achievable forecasts, and effectively communicate the various actions taken to maintain capital adequacy and manage the company’s risk profile. It’s critical for management to understand the agencies expectations prior to engaging discussions presenting material at an annual review.

Newsletter – March 2017

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The New CECL Approach

Tom Van Lenten, CPA, CFO Consulting Partners LLC

In mid-2016 the FASB issued its long-awaited standard on accounting for credit losses (ASU 2016-13). The new standard adds to US GAAP an impairment model known as the current expected credit loss model or CECL. In a shift from current practice the CECL model is based on expected losses rather than incurred losses. Under the new CECL model an entity recognizes its forward looking estimate of the expected credit losses in the Allowance for Loan and Lease Losses, or ALL when an asset is booked.

The FASB believes that the new standard will result in more timely recognition of credit losses. There is a long transition timeline and implementation is required at January 1, 2020 for calendar-year reporters that are SEC filers, and January 1. 2021 for other entities.

The CECL approach is to be applied to most debt instruments that are not measured at fair value. This includes loan commitments, financial guarantees, lease receivables, trade receivables and held-to-maturity securities. Available for sale debt securities are specifically excluded and will continue to be evaluated for impairment under the AFS securities impairment model.

The Standard does not require use of any one method to compute expected credit losses. Management is expected to maintain complete data sets, documentation, and analysis to support how the selected method fits with the standard and produces realistic estimates of future losses. Examples of some of the acceptable methodologies are:

  • Loss rate: Historical loss rates can still be used as a starting point for determining expected credit losses. When using historical loss rates, the Bank would have to consider how conditions that existed during the historical charge-off period differ from current projections and adjust the future loss rates accordingly.
  • Discounted cash flow: Projections of principal and interest flows over the life of the asset.
  • Probability of default method estimates the probability loans in certain risk-stratified segments will default. This approach computes the percentage of loans that have defaulted in a pool over a look-back period.
  • Roll-rate method. The roll-rate method is often referred to as “migration analysis”. It is based on determining a prediction of credit losses based on segmentation (by delinquency or risk rating, for example) of a portfolio of financial assets. No standard roll-rate model is used throughout the financial institutions industry, but most of the models used are based on similar underlying principles.
  • Aging analysis: Banks use aging analysis in determining the effectiveness of their credit and collections functions and for estimating potential loan losses. The information from this analysis is used by Banks as a component of their estimate the allowance for loan & lease losses.
  • Collateral-value: For loans that are collateral dependent, evaluation of collateral and costs of disposal can be used to estimate expected credit losses.

Institutions with multiple loan types will likely need several methodologies to properly analyze the loss content of each portfolio segment and then aggregate the results to understand the expected losses for entire loan portfolio.

Expected credit impairment will be recognized as an allowance, instead of as a direct write-down of the amortized cost of the financial asset. Changes to the ALLL are recorded immediately through credit loss expense. The carrying amount of a financial asset that is considered to be uncollectible will be written-off in a manner similar to current US GAAP.

While there is significant time until required implementation, it is imperative that management begin the implementation process as soon as possible. The most problematic aspects of CECL implementation will likely be: a) developing the support systems and processes, b) gathering and organizing the historical data to support new methodologies, and c) developing going forward data capture and analysis processes.

  • With respect to a) above, existing modeling approaches currently used for Basel, and stress testing may be leveraged and adapted for CECL. However, new credit loss models will likely need to be implemented. It is anticipated that the development or purchase of credit models that estimate future credit losses may be the most time consuming phase of CECL implementation.
  • For b) the historical data requirements for the new models will often not be resident in current financial and credit systems. This data will have to be developed from the bank’s core operating system and organized into databases which the models can access.
  • For data capture and analysis c) the starting point for developing a future loss credit loss data base is current loan and credit loss data. Companies implementing CECL should undertake a robust review and analysis of its current loan and credit data so that the process of developing a future credit loss data base starts with historic data that has a high level of accuracy and integrity.

Many of the disclosures required under the new standard are similar to those required under current GAAP. For example disclosures on credit quality, ALLL roll-forward, policies tor determining credit losses, past due and non-accrual status, and collateral dependent assets are the same. There are, however, significant additional disclosures of credit quality indicators, disaggregated by year of origination for a five-year period.

Newsletter – February 2017

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Quality Assurance – Important?

What is the Problem?

Many firms, particularly smaller ones, have problems with controls or Quality Assurance (“QA”) over the “downstream” preparation of financial statements, footnotes and MD&A. Typically, “upstream” processes like AP, Cash, Journal Entries, etc. are strictly controlled, but limited staff and insufficient planning can lead to downstream QA issues. The complexities and ever-evolving accounting standards (e.g. Revenue Recognition., etc.) create challenges for any firm, while managements and boards have potential individual liability for errors and misleading reporting. The new administration’s focus on deregulation is unlikely to give relief from getting the reporting right, while senior SEC personnel have publicly stated their concerns about firms’ controls over implementing the new accounting standards.

A weak downstream QA process that results in errors in work papers, statements etc. being passed on to the firm’s independent auditors will cause more audit checking and testing, raising the cost and potentially leading to a material weakness being declared. Worse still, a weak QA process may result in the need for an embarrassing restatement.

Picking up wrong numbers as well as making calculation, factual and spreadsheet mistakes are common errors. “Version Confusion” also happens when nobody is sure which versions have been checked and updated. The risk of error increases with: more Excel spreadsheets; more manual hand-offs; limited available staff time; late changes; multiple, geographically dispersed operating subsidiaries, etc.

What is the Solution?

The goal of the QA process is to substantially reduce the probability of errors by ensuring that all numbers and narratives agree to back-up, all tables foot and, all calculations are correct and all disclosures are complete and make sense and the whole report is internally consistent. Best practices have the QA process built: (1) into the firm’s workflow with specific steps, defined responsibilities including a central point of control; and (2) into the firm’s timeline with sufficient time to ensure quality, with due consideration for last minute changes. All back-up support should be gathered into one location as on-line soft copy for easy access.

Preferably the QA responsibility is assigned to a person/team not involved in the day-to-day report preparation – smaller firm might consider outside support. The QA person then undertakes: checking the whole report; distributing a formal Issues Log; checking and logging changes being made; final checking of the main statements; and signing off with finance management. The QA person needs to be well skilled, not a junior, and should also be able to make a critical assessment of the back-up support.

Additional documentation should be maintained including the Issues log, work papers and a summary of the main QA steps undertaken signed off by the QA person and finance management.

All the same QA considerations apply if the firm is not a public company but is facing a major financial transaction (e.g. equity/ debt raises, PE investment, sale of firm, etc.) to avoid the loss of credibility from errors uncovered in due diligence.

There is real value in having a well-defined downstream QA process as part of robust Internal Control over Financial Reporting (“ICFR”) to ensure the firm’s financial reporting is accurate and transparent.

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Our firm is a team of senior financial executives. We provide a broad range of financial management services to public and private companies. We work for CEOs, CFOs, Controllers, as well as audit committees and boards.

Our mission is to apply our consultants’ considerable collective experience to resolve client issues in a professional and efficient manner.

Newsletter – January 2017

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Guest Article from iSiegel Consulting: Justifying the Spend on IT Security

Overview

Companies that underfund security intiatives wind up undermining a company’s ability to protect its information assets. The results can be catastrophic. IT leaders and CFOs need to understand the severity of the situation, specifically what the risks are and most importantly, how to present the business value of making the investment to upper management (CEO and board memebers). Here’s what’s to be done.

Justification

Upper management can easily come up with a hundred reasons not to properly fund security initiatives. And when they do fund they may not be investing wisely. Often the decision not to fund occurs when the executives lack adequate information to make an investment.

The best strategy is to consider Security as part of Risk Management. The strength of the argument on whether or not to fund rests on determining what the risk is to the organization, what losses can be incurred from the risk and how much it will cost to mitigate that risk. With this information upper management can decide whether it is worth the expenditure. What may shock the CFO is the degree of risk his company is facing. There is no need to exaggerate here. The risk most companies face is substantial enough to get the attention of the CFO.

Company executives will feel more comfortable investing in security when the business case and financial terms are solid and upper management is given choices of security strategies and investments to compare. Once funded, reporting strategies and regular statuses to upper management that are informative and clearly stated build credibility are necessary.

Identifying security problems

Fortunately the tools, such as intrusion detection systems and firewall logs, are readily available, and can determine where security problems already exist in your organization. These tools produce a mountain of data and can provide excellent supporting evidence for many security investment decisions.

The downside to using these tools to collect and assess network and system data is that they require a serious commitment in both time and effort. However, you will find the effort is well worth it as hard data makes the most compelling case for security investments.

Summary

Including in your deliverables a status report on how well things have gone is the last major step that upper management needs. Good communication is key. Measuring success or lack of it and making clear to management how success will be measured is important. A no nonsense semi-annual report is a great way to build credibility. Executives will then know which investments are paying off and which are not and should be cut back. This report is a great way to gain the respect of C level executives and their support for future projects.

Who we are

iSiegel Consulting is a technology firm made up of senior IT executives. We provide services to CFOs and upper management who have need for immediate solutions that improve performance, reduce spend and increase operational efficiency. We commonly work with CEOs, CFOs and Board of Directors of small to medium sized companies.

We principally focus on three technology challenges: Cyber Security; Budget/Project Management; and Compliance and Governance Design. Our teams of CIOS, CTOs and senior admins find solutions to the most demanding operational and organizational challenges facing organizations. More about us at http://isiegelconsult.com

Newsletter – December 2015

By

Financial Transparency – A Case Study

The following is a composite case of several organizations, and any resemblance to an actual client is clearly coincidental.

Background:
A client suffered fraud, misappropriated funds, and confused financial concepts. This caused lots of frustration at the board level. The audit report took almost a year to complete, and the auditing firm pointed out a number of material weaknesses, which went years without being adequately addressed.

What was the problem? The accounting process was opaque, bookkeeping practices were cumbersome, information was not captured at a correct reportable level, internal controls were weak; executive management did not have appropriate skills, and most importantly, the board did not understand the way information was reported (too high-level with weak explanations). This resulted in serious cash flow problems.

Here is how the board/company addressed the problem:

Quality of staff – The board insisted that the accounting and executive staff be upgraded and reorganized, and that the new CEO be very close to the numbers.

Discipline – The board insisted on a standard financial reporting package. This consisted of a balance sheet, P&L, cash flow report, variance analyses of this year versus the prior year, accounts receivable and accounts payable aging reports, and other standard reports.

Restructuring the way information was reported – It is now reported in the way that the business is run. This meant a redo of the chart of accounts to re-organize the way information was reported and to capture certain information at a more detailed level.

Policies and procedures – They were developed in bullet point form; they were kept to a few pages and reviewed and approved by the board, and are now followed by senior management. For example, capital expenditures, which could be masked by leasing equipment in which the monthly payments are in relatively small amounts, could no longer fall under the radar.

Sense of openness:
The new CEO and the board encouraged openness in reporting and telling it like it is. Any spin was discouraged. Businesses were separately reported so one could see the contribution profit. A strategic plan preceded the budgeting process and the fist year of the plan became the budget.

Result:
The organization is on its way to meeting its goals with a renewed sense of excitement, and with a financial process that tells it like it is.
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Our firm is a team of senior financial executives. We provide a broad range of financial management services to public and private companies. We work for CEOs, CFOs, Controllers, as well as audit committees and boards.

Our mission is to apply our consultants’ considerable collective experience to resolve client issues in a professional and efficient manner.

We are a proud member of FINACA. FINACA is a nationwide network of independent finance and accounting consulting firms focused on delivering exceptional client service. Learn more...

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