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Lobbying and politics and education, oh my!

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Emily is a Senior in BerryDunn’s Tax Consulting and Compliance Practice Group and specializes in not-for-profit tax compliance. Emily works with clients throughout New England to understand their needs and ensure they are met. She provides a number of services in the healthcare and not-for-profit sectors, specializing in areas such as tax-exempt reporting requirements of public charities and private foundations.

Emily Saunders
03.31.22

Read this if you are a not-for-profit organization.

With springtime upon us, it may be difficult to start thinking about this upcoming fall, but that is exactly what many folks in the nonprofit sector are starting to do. The reason for this? It’s because 2022 brings with it the mid-term election cycle. While technically an off-year election, many congressional and gubernatorial races are being contested, in addition to a myriad of questions that will appear on ballots across the country. It is around this time of year we start to see many questions from clients in the nonprofit sector in the area of political campaign activities, lobbying (both direct and grassroots), and education/advocacy.

This article will discuss the three major types of activities nonprofit organizations may or may not undertake in this arena and will offer guidance to give organizations the vote of confidence they need to not run afoul of the potential pitfalls when it comes to undertaking these activities.

Political campaign activity

Political campaign activities include participating or intervening in any political campaign on behalf of (or in opposition to) any candidate for elective public office, be it at the federal, state, or local level. Examples of such activities include contributions to political campaigns as well as making public statements in favor of or in opposition to any candidate. The IRS explicitly prohibits section 501(c)(3) organizations from conducting political campaign activities, the consequence of doing so being loss of exempt status. However, other types of exempt organizations (such as 501(c)(4) organizations) are allowed to engage in such activities, so long as those activities are not the organization’s primary activity. Only Section 527 organizations may engage in political campaign activities as their primary purpose. 

Direct lobbying

Direct lobbing activities attempt to influence legislation by directly communicating with legislative members regarding specific legislation. Examples of direct lobbying include contacting members of Congress and asking them to vote for or against a specific piece of legislation.

Grassroots lobbying

Grassroots lobbying, on the other hand, attempts to influence legislation by affecting the opinions of the general public and include a call to action. Examples of grassroots lobbying include requesting members of the general public to contact their representatives to urge them to vote for or against specific legislation.  

A quick way to remember the difference:
Political = think “P” for People – advocating for or against a specific candidate 
Lobbying = think “L” for Legislation – advocating for or against a specific bill

Education/advocacy

Organizations may engage in activities designed to educate or advocate for a particular cause so long as it does not take a specific position. For example, telling members of Congress how grants helped constituents would be considered an educational activity. However, attempting to get a member of Congress to vote for or against specific piece of legislation that would affect grant funding would be considered lobbying. Another example would be educating or informing the general public about a specific piece of legislation. Organizations need to be mindful here as taking a specific position one way or the other would lend itself to the activity being deemed to be lobbying, and not merely education of the general public. There is no limit on how much education/advocacy activity a nonprofit organization may conduct.

Why does this matter?

As you can see, there is a very fine line between lobbying and education, so it is important to understand the differences so that an organization conducting educational activities does not inadvertently end up conducting lobbying activities.

Organizations exempt under Code Section 501(c)(3) can conduct only lobbying activities that are not substantial to its overall activities. A 501(c)(3) organization may risk losing its exempt status and may face excise taxes on the lobbying expenditures if it is deemed to be conducting excess lobbying, whereas section 501(c)(4), (c)(5), and (c)(6) organizations may engage in an unlimited amount of lobbying activity.

What is substantial?

Unfortunately, there is no bright line test for determining what is considered substantial versus insubstantial. As an industry standard, many practitioners have taken a position that insubstantial means five percent or less of total expenditures, but that position is not codified and could be challenged by the IRS. 

Section 501(c)(3) organizations that intend to conduct lobbying activities on a regular basis may want to consider making an election under Code Section 501(h). This election is only applicable to 501(c)(3) organizations and provides a defined amount of lobbying activity an organization may conduct without jeopardizing its exempt status or becoming subject to excise tax. The 501(h) election limit is based on total organization expenditures with a maximum allowance of $1 million for “large organizations” (defined as an organization with total expenditures over $17,000,000). 

While the 501(h) election provides some clarity as to how much lobbying activity can be conducted, it may be prohibitive for some organizations whose total expenditures greatly exceed the $17,000,000 threshold. Another item to be aware of is that the lobbying threshold applies to all members of an affiliated group combined, which means the entire group shares the maximum threshold allowed. 

Another option for those engaging in lobbying is to create a separate entity (such as a 501(c)(4) organization) which conducts all lobbying activities, insulating the 501(c)(3) organization from these activities. As previously mentioned, organizations exempt under Code Section 501(c)(4) can conduct an unlimited amount of lobbying activities but can only conduct limited political campaign activities.

What about political campaign activities?

Section 527 organizations, known as political action committees, are exempt organizations dedicated specifically to conducting political campaign activities. If a 501(c)(4), (c)(5), or (c)(6) organization makes a contribution to a 527 organization, it may be required to file a Form 1120-POL and be subject to tax at the corporate tax rate (currently a flat 21%) based on the lesser of the political campaign expenditures or the organization’s net investment income. State income taxes may also be applicable. Section 501(c)(3) organizations may not make contributions to 527 organizations. 

If your organization is considering participation in any of the above activities, we would recommend you reach out to your not-for-profit tax team for additional information. We’re here to help!

Topics: not-for-profits

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Read this if you are in the senior living industry.

The COVID-19 pandemic wreaked havoc on the country and created challenges across the labor force, and senior living facilities weren’t spared. For senior living, the pandemic contributed to the widening of the care cost shortfall, by decreasing the available workforce pool through voluntary resignations and a demand for higher wages. That situation has remained, and senior living facilities are faced with many challenges, including rising labor costs. Of note: 

  • Across the nation, contract nursing labor utilization continues to increase, with an average 35% increase in contract agency hours used per patient day from 2020 to 2021.1 
  • Occupancy has been declining nationwide, driven by both diminishing referrals (infection control concerns, reduction of elective procedures, such as joint replacements, and hospital capacity limitations), and the ability of facilities to accept patients (suspension of admissions due to inadequate staffing).
  • Rising costs and diminishing occupancy have resulted in an average SNF $178.65 per patient day cost of care increase, from 2020 to 2021.
  • Nationally, the US Bureau of Labor Statistics2 (BLS) reports nursing and residential care facility employment declined 5% from 2019 to 2020, and further 5.7% from 2020 to 2021. Competition for workers resulted in noticeable wage increases, 10.4% in 2020, and 5.6% in 2021 (Table 1). 

Table 1: Employment and wages, 2019 – 2021

The first quarter of 2022 reveals a continuing reduction of employment coupled with continuing wage increases in the industry. The first quarter of 2022 showed an 11.4% increase in average weekly wage for nursing and residential care facilities over that same period in 2021, and continuing decline in employment (Table 2). 

Table 2: Employment and wages, Q1 2022

COVID-19 related staff burnout, lack of childcare or school schedule disruptions, infection control requirements, such as mandatory masking or vaccinations, and other factors resulted in a rapid and significant reduction of clinical staff available for work. 

Additional factors, such as migration of clinical staff from facility-based employment to a temporary contract agency, may have also contributed to the reduction of workforce in clinical occupations. CMS SNF Provider Information3 data comparison between August 2021 and August 2022 shows that all US regions reported a decline in average case-mix adjusted direct care hours per patient day (Figure 3) within a year. On average, 7.89% reduction in total hours reported, or 0.32 hours of services less per patient day. It is important to note that utilization of unlicensed staff (nursing assistants) has not changed significantly (57.2% in 2021 and 57.7% in 2022), indicating that nationwide availability of both licensed (RN, LPN) and unlicensed staff has decreased. 

Table 3: Average case-mix adjusted direct care hours per patient day – August 2021 and August 2022 comparison

Our interviews with long-term care facilities across the US have revealed that a number of facilities had to suspend admissions for a period of time, or close a portion of the facility, due to limited or inadequate staffing levels. Due to the nature of services, it mostly affects short stay rehabilitation unit admissions. For the majority of facilities, short stay revenue sources (such as Medicare) are more favorable and normally more profitable than long-term stays. The decrease in census (Table 4) drives the per diem costs up, and the loss of short-stay revenue continues to negatively impact the bottom line. Additionally, with a significant reduction of short stay rehabilitation volume, some highly trained employees of the facilities (such as therapists, clinical directors, dieticians, and others) may be less utilized, and potentially harder to retain. 

Table 4: Average Medicare-certified facility occupancy, 2019 – 2021

The increased cost of labor is one of the major per diem cost increase drivers for senior living facilities. The tight labor market has led to higher labor costs, increased utilization of contract labor, as well as reductions or suspensions in admissions due to lack of staffing. 

Table 5: Average Medicare-certified facility direct care labor cost per patient day (wages, benefits, contract labor), 2019 – 2021

Table 6: Average Medicare-certified facility direct care contract wages, 2019 – 2021

Many states facilitate labor-related programs aimed at increasing labor pool and staff retention through innovative programs, as well as considering waivers related to staff certification and delegation of duties requirements. Due to timing, the job outlook could not be forecasted with the effects of the new initiatives, as there is no data yet available on effectiveness of these programs.
If you would like more information, or have questions about your specific situation, please contact our senior living and long-term care team. We’re here to help.

HCRIS as filed SNF Medicare (full utilization) cost reports, 2019 – 2021
Bureau of Labor Statistics, 2022
The Centers for Medicare & Medicaid Services, 2022

Article
Current senior living industry trends and challenges—spotlight on labor costs

Read this if you are a plan sponsor of employee benefit plans.

Employee Retention Credit (ERC)

There is still time to claim the Employee Retention Credit, if eligible. The due date for filing Form 941-X to claim the credit is generally three years from the date of the originally filed Form 941. 

The ERC is a refundable payroll tax credit for wages paid and health coverage provided by an employer whose operations were either fully or partially suspended due to COVID-related governmental orders or that experienced a significant reduction in gross receipts. 

The amount of the credit can be substantial. For 2020, the credit is 50% of the first $10,000 of qualified wages per employee for the qualifying period beginning as early as March 12, 2020, and ending December 31, 2020 (thus the max credit per employee is $5,000 in 2020). For 2021, the credit is 70% of the first $10,000 of qualified wages per employee, per qualifying quarter (thus the potential max credit is $21,000 per employee in 2021). 

For 2021, employers with 500 or fewer full-time employees in 2019 may include all wages and health plan expenses as qualified wages. For 2020, employers with 100 or fewer full-time employees in 2019 may include all wages and health plan expenses as qualified wages while employers with more than 100 full-time employees in 2019 may only claim the credit for qualified wages paid to employees who did not provide services. For purposes of determining full-time employees, an employer only needs to include those that work 30 hours a week or 130 hours a month in the calculation. Part-time employees working less than this would not be considered in the employee count.

There is additional interplay between claiming the ERC and the wages used for PPP loan forgiveness that will need to be considered. 

Student loan repayment programs

One of the benefits younger employees would like to receive from their employer is assistance with student loan repayments. A recent study indicated an employee would commit to working for an employer for at least five years if the employer assisted with student loan payments. Some employers have been providing such a benefit and, until 2020, any student loan payments made by the employer would have been considered taxable income. 

Beginning in 2020 and through 2025, at least for now, employers are permitted to provide tax-free student loan repayment benefits to employees. In order to receive tax-free payments, such a plan must be in writing and must be offered to a non-discriminatory group of employees. In addition, the tax-free benefit must be limited to $5,250 per calendar year. Now may be the time to consider offering student loan repayment benefits to help retain and attract employees.

Automatic enrollment for employee deferrals in 401(k)/403(b) plan

Most employers offer an employer-sponsored retirement plan such as a 401(k) plan or 403(b) plan to their employees. However, the federal government and several state governments are concerned that employees are either not saving enough for retirement and/or do not have access to an employer-sponsored retirement plan. Some states are mandating the establishment of an employer-sponsored retirement plan, or mandatory participation in a state-sponsored multiple employer plan (MEP). Other states are mandating that employers who do not sponsor a 401(k) or 403(b) plan provide automatic employee payroll deductions into a state-sponsored Individual Retirement Account (IRA) type vehicle sponsored by the state. If you do not already sponsor a 401(k) or 403(b) plan you should confirm if your state has any requirements.

For those employers who do sponsor a 401(k) or 403(b) plan, you should consider implementing an automatic enrollment provision if you have not done so already. Automatic enrollment requires a certain percentage of an employee’s wages to be withheld and deposited into the 401(k) or 403(b) plan each pay period, unless the employee elects otherwise. While the current law does not require an employer to use automatic enrollment, there is pending legislation that would require an automatic enrollment provision in any new retirement plan. Even though existing plans would be grandfathered under the pending legislation, it may be worth implementing an automatic enrollment provision in the 401(k) or 403(b) plan to help and encourage employees to save for retirement. 

If you have questions about any of these or other employee benefit topics, please contact our Employee Benefits Audit team. We're here to help.

Article
Employee benefit plan updates: The Employee Retention Credit and student loan repayment programs

Read this if you are subject to Medicaid DSH audits.

The Medicaid DSH program, created in 1981, provides funding to hospitals in the form of DSH payments. Federal law requires that state Medicaid programs make DSH payments to hospitals that serve a disproportionately high number of Medicaid beneficiaries and uninsured low-income patients, to help offset uncompensated care costs (UCC). With healthcare costs steadily outpacing income growth and inflation, these DSH payments serve as an important and sometimes necessary reimbursement mechanism. 

In most states, hospitals that receive Medicaid DSH payments are subject to an annual DSH audit, to determine the DSH UCC limit and to compare it against DSH payments received from the Medicaid state agencies. The DSH UCC limit uses information from the Medicare cost report, as well as Medicaid and uninsured patient detail, to calculate the UCC. 

Upon completion of the DSH audit, the Medicaid state agency or its contractor will compare the UCC to the DSH payments issued during the state fiscal year to determine if a hospital is in a shortfall, where DSH payments were less than the UCC, or a "longfall", where DSH payments were greater than the UCC. If it is determined that a hospital is in a longfall, the state’s Medicaid plan may require hospitals to pay some or all of the DSH funds back. With potentially significant financial implications, it is in the hospital’s best interest to understand the requirements and to complete the audit in a timely and accurate fashion. 

Completion of the DSH audit can be a daunting task. For some, the mere mention of the words “DSH audit” is enough to send chills down one’s spine. It is best assigned to those with solid reimbursement, revenue cycle, hospital operations, and information management system (IT) knowledge. 

It is not uncommon for hospitals to have a consulting firm, such as BerryDunn, complete the DSH audit on their behalf. While the DSH audit may seem like a heavy lift, we hope the following tips will assist you in tackling the audit and getting through the process smoothly and efficiently. 

  1. Allow enough time for completion of the DSH audit. A considerable amount of time and effort is needed to collect, reconcile and summarize the internal claims data and to enter information into the required schedules. The time needed to complete the audit will depend on your organization’s available resources and complexity of the IT and financial systems. Typically, this process takes one to two weeks to complete, sometimes longer. Creating the patient data support files themselves is arguably the most time-consuming aspect of the process. 
  2. Review the minimum federal requirements for DSH payment eligibility and document your organization’s qualifications. To receive DSH payments, hospitals must have a low-income inpatient utilization rate (LIUR) greater than 25 percent, or the hospital must have a Medicaid utilization rate (MIUR) that is at least one standard deviation above the mean rate of all hospitals in the state that receive Medicaid payments. States may distribute DSH payments to other hospitals provided they have a MIUR of at least one percent, and if they offer obstetric services that they have at least two OB/GYN on staff.
  3. Take time to understand how DSH payments are calculated in your state and if any recent state Medicaid plan changes may affect your organization’s eligibility and amount of qualifying payments. 
  4. Carefully review any audit instructions provided, paying particular attention to types of claims, service dates, and required supporting information. 
  5. Gather all the data files needed for completion of the DSH audit before diving in, including the cost report(s) for the period under audit, patient data support files that support the Medicaid and uninsured populations, and audited hospital financial statements (if applicable). Remember: bad data in, bad data out!
  6. Reconcile the state claims data. If the state claims data is used by the state Medicaid agency or its contractor to complete a portion of the audit, we strongly recommend a reconciliation of the state claims data to internal records, to help ensure all eligible claims, inpatient days, and charges are included.
  7. Identify and capture all Medicaid and uninsured patients. When completing schedules, hospitals should ensure they are identifying and capturing all Medicaid and uninsured patients, and accurately report the charges and payments for these patients for the DSH audit. Certain data elements are required, including patient demographic data and hospital charge and payment information. 
  8. Review insured patients' claims with no insurance payment. For uninsured patient charge capture, hospitals may benefit from reviewing insured patients’ claims with no insurance payment. Some claims, meeting state Medicaid plan coverage requirements, could be included as “uninsured” if they meet one of the three exclusion requirements: (1) service was not covered by insurance, but is covered by a Medicaid state plan; (2) patient’s benefits were exhausted prior to the admission/service date, and (3) patient reached the lifetime insurance limit. Some accounts that appear to be insured on the surface may in fact be eligible for inclusion in the calculation of the UCC. Remember, claims denied by insurance, such as untimely filing, lack of pre-authorization, or medically unnecessary services, should not be reported. In many cases, the only way to know for sure if an account can be included is through research of patient notes and financial information. Leave no stone unturned! It could be the difference between a longfall and a shortfall in your UCC.
  9. Review your work prior to submission. Many states will provide a checklist with the audit package, to ensure all data elements have been included with the submission. Even if the hospital has resources to complete the audit, consider arranging for a third-party review of the DSH audit and other submission items to help ensure the accuracy and completeness of the data. 
  10. Schedule time to review audit adjustments. The Medicaid state agency or its contractor will likely provide an adjustment report for your review. Plan your time for review of the audit adjustments, as the window for response or amendments may be very narrow. Take note of the adjustments, especially the high dollar ones, and either confirm that they are accurate or make revisions as necessary. This is another opportunity to bring in an advisor for a second review. 

Should you have any questions about or during the DSH reporting process, please do not hesitate to reach out to Andrew Berube and Olga Gross-Balzano at BerryDunn. We’d be pleased to serve as a second set of eyes to your process or alleviate the time requirements on your finance team. 

Andrew Berube
aberube@berrydunn.com
207-239-9893

Olga Gross-Balzano
OGross-Balzano@berrydunn.com
207-842-8025

Article
Medicaid Disproportionate Share Hospital (DSH) audits: 10 tips for a successful audit

Read this if you want to understand the new lease accounting standard.

What is ASC 842?

ASC 842, Leases, is the new lease accounting standard issued by the Financial Accounting Standards Board (FASB). This new standard supersedes ASC 840. For entities that have not yet adopted the guidance from ASC 842, it is effective for non-public companies and private not-for-profit entities for reporting periods beginning after December 15, 2021.

ASC 842 (sometimes referred to as Topic 842 or the new lease standard) contains guidance on the accounting and financial reporting for agreements meeting the standard’s definition of a lease. The goal of the new standard is to:

  • Streamline the accounting for leases under US GAAP and better align with International Accounting Standards lease standards 
  • Enhance transparency into liabilities resulting from leasing arrangements (particularly operating lease contracts)
  • Reduce off-balance-sheet activities

What is the definition of a lease under the new standard?

ASC 842 defines a lease as “A contract, or part of a contract, that 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.” 

This definition outlines four primary characteristics to consider: 1) an identified asset, 2) the right to control the use of that asset, 3) a period of time, and 4) consideration.

(For a deeper dive into what constitutes a lease, you can download the BerryDunn lease accounting guide here.) 

How will this affect your organization?

  • Lease arrangements have to be classified as finance, operating, or short-term leases. In general accounting for the lease asset and liability is as follows:

    • For finance leases, use the effective interest method to amortize the liability, and amortize the asset on a straight-line basis over the lease term. Note that this has the effect of “front-loading” the expense into the early years of the lease.

    • For operating leases (e.g., equipment and some property leases), the lease asset and liability would be amortized to achieve a straight-line expense impact for each year of the lease term. ASC topic 842 establishes the right-of-use asset model, which shifts from the risk-and-reward approach to a control-based approach. 
  • Lessees will recognize a lease liability of the present value of the future minimum lease payments on the balance sheet and a corresponding right of use asset representing their right to use the leased asset over the lease term. 
  • The present value of the lease payments is required to be measured using the discount rate implicit in the lease if its readily determinable. More likely than not it will not be readily determinable, and you would use a discount rate that equals the lessee’s current borrowing rate (i.e., what it could borrow a comparable amount for, at a comparable term, using a comparable asset as collateral).
  • It will be critical to consider the effect of the new rules on your organization’s debt covenants. All things being equal, debt to equity ratios will increase as a result of adding lease liabilities to the balance sheet. Lenders and borrowers may need to consider whether to change required debt to equity ratios as they negotiate the terms of loan agreements.

Time to implement: What do you need to do next?

The starting place for implementation is ensuring you have a complete listing of all known lease contracts for real estate property, plant, and equipment. However, since leases can be in contracts that you would not expect to have leases, such as service contracts for storage space, long-term supply agreements, and delivery service contracts, you will also need to broaden your review to more than your organization’s current lease expense accounts. 


We recommend reviewing all expense accounts to look for recurring payments, because these often have the potential to have contracts that contain a lease. Once you have a list of recurring payments, review the contracts for these payments to identify leases. If the contract meets the elements of a lease—a contract, or part of a contract, that 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—your organization has a lease that should be added to your listing.

Additionally, your organization is required to consider the materiality of leases for recognition of ASC 842. There are no explicit requirements (that, of course, would make things too easy!). One approach to developing a capitalization threshold for leases (e.g., the dollar amount that determines the proper financial reporting of the asset) is to use the lesser of the following: 

  • A capitalization threshold for PP&E, including ROU assets (i.e., the threshold takes into account the effect of leased assets determined in accordance with ASC 842) 
  • A recognition threshold for liabilities that considers the effect of lease liabilities determined in accordance with ASC 842

Under this approach, if a right-of-use asset is below the established capitalization threshold, it would immediately be recognized as an expense. 

It's important to keep in mind the overall disclosure objective of 842 "which is to enable users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases". It's up to the organization to determine the level of details and emphasis needed on various disclosure requirements to satisfy the disclosure objective. With that objective in mind, significant judgment will be required to determine the level of disclosures necessary for an entity. However, simply put, the more extensive the organization's leasing activities, the more comprehensive the disclosures are expected to be. 

Don't wait, download our lease implementation organizer (Excel file) to get started today! 

Key takeaways and next steps:

  •  ASC 842 is effective for reporting periods beginning after December 15, 2021
  • Establish policies and procedures for lease accounting, including a materiality threshold for assessing leases
  • Develop a system to capture data related to lease terms, estimated lease payments, and other components of lease agreements that could affect the liability and asset being reported
  • Evaluate if bond covenants or debt limits need to be modified due to implementation of this standard
  • Determine if there are below market leases/gifts-in-kind of leased assets

If you have questions about finance or operating leases, or need help with the new standard, BerryDunn has numerous resources available below and please don’t hesitate to contact the lease accounting team. We’re here to help. 

Lease accounting resources 

Article
ASC 842 lease accounting—get started today before it's too late

Read this if you are at a financial institution. For more CECL information, tune in to the latest episode of BerryDunn’s CECL Radio podcast. It features Susan Weber and David Stone discussing how to handle unfunded commitments and debt securities during CECL preparation.

I love a big surprise! Of course, I mean the fun, uplifting kind—like birthday parties, a best friend’s unexpected visit, or that special anniversary gift. Not that other kind of surprise that’s more like biting into an apple only to find half a worm. Calculating a loss reserve for unfunded commitments is not a new concept, but the reach and significance of it may end up surprising institutions. How much? A review of 2020 public filings and disclosures shows that some adopters saw unfunded commitment reserves increase millions of dollars, from one percent of total reserves pre-adoption to six percent or more post-adoption. In this article, we take a close look at unfunded commitments under CECL, in an effort to help you avoid that “other kind” of surprise.  

Within the CECL standard (Accounting Standards Codification (ASC) 326 – Financial Instruments-Credit Losses), key considerations for estimating reserves tied to unfunded commitments are covered in section 326-20-30-11. The section lays out three key fundamentals: it applies to credit commitments that are not unconditionally cancellable, and that institutions should consider how likely the commitment is to be funded, and its expected life. 

First, let’s look at unconditionally cancellable—this essentially means that unless an institution can, at any time and for any reason, cancel its commitment to lend, then the commitment has to be included in this part of the estimate. Institutions may be surprised to discover that a portion of its commercial sales pipeline should now be included in unfunded commitment balances. Why? Because commitment letters issued to business loan applicants are often considered legally binding and they typically do not contain language that would make them unconditionally cancellable by the institution. This makes sense when you realize the primary goal of the commitment letter is to assure the applicant that the bank is committed to making the loan. This discovery, in turn, has led those involved in CECL implementation to develop (1) processes to ensure commercial loan pipelines are sufficiently detailed enough to know what, when, and how these commitments should be included in the calculation, and (2) internal controls that assure the accuracy, completeness, and timeliness of the information. 

Next up—how likely is it that the commitment will be funded? For unused portions of existing loans and lines, this may mean taking a look at average utilization rates. For in-scope pipeline commitments, institutions may find that they need to dig through information that is not commonly held in a central system to come up with a success or close rate. The likelihood of funding may vary widely between products or segments, and over its expected life. For example, the expected funding of a residential or commercial real estate construction line may approach 100%, whereas only 40% or less of a revolving line may ever be used. These funding rates become the basis for “discounting” the unfunded balances subject to reserve estimation and should be re-evaluated on some periodic basis, which can be detailed in the institution’s CECL model documentation related to governance and monitoring.

Finally, let’s look at the expected life of the loan component. This language and expectation are consistent with on-balance sheet credit, leading institutions to (1) make sure they are able to segment their off-balance sheet commitments in the same pools used for boarded loans, and (2) apply the appropriate pool reserve factor to unfunded commitments over the expected life of that type of loan. One-way institutions may accomplish this is by making sure that they are using the same fully adjusted reserve factor and expected life assumptions for unfunded pools as they do for their funded pool counterparts. 

You may discover that your CECL model or software vendor does not provide for unfunded commitment calculations, or only provides support for the available credit portion of loan facilities boarded to your core loan system. In either case, this means institutions must consider, support, and complete calculations outside of the model. Writing clear step-by-step instructions and ensuring a robust independent review/approval process will help off-set risks posed by such manual calculations.

Could you use an experienced resource to help you document or validate your CECL model?  

No matter what stage of CECL readiness you are in, we can help you navigate the requirements as efficiently and effectively as possible. For more information, visit the CECL page on our website. If you would like specific answers to questions about your CECL implementation, please visit our Ask the Advisor page to submit your questions.

For more tips on documenting your CECL adoption, stay tuned for our next article in the series. You can also follow Susan Weber on LinkedIn.

Article
Unfunded commitments and CECL: You may be in for a big surprise

Read this if you are a business owner or are interested in business valuation. 

BerryDunn’s business valuation team recently authored a book titled A Field Guide to Business Valuation for Owners and Leaders of Private Companies. It is being published by Business Valuation Resources, the leading provider of valuation textbooks, in September. 

A book’s cover can say a lot about a book, and this one is no exception. The title of this book is A Field Guide to Business Valuation. We have organized the book like a field guide used by bird watchers, and encourage readers to keep it on hand as a reference. It doesn’t necessarily need to be read cover to cover. Jump around. If a question comes up about a particular topic, turn to the section that addresses that matter. Or, if learning all about business valuation sounds appealing, by all means read it cover to cover. You may find more to certain topics than you initially thought. Here are some of our notes about the book.

We wrote this book based on data from the field. It is based on our experiences helping business owners estimate, preserve, and increase business value. We work with people who don’t have a business valuation background. We regularly use simple analogies to help people understand complicated topics. We get used to answering the same questions that come up, and we have had many opportunities to hone our answers. After years of explaining business valuations in conversations and presentations, we wrote this book to provide more people with a greater understanding of how businesses are valued. 

This book is intended for business owners and their advisors who would like to learn more about how to estimate what a business is worth, what factors affect value, and how to make businesses more valuable. After reading this book, the reader should be conversant in business valuations and comfortable with the overall valuation framework. It is not an exhaustive dissertation on business valuation. There are many other (very thick) books that get into the details, picking up where this book leaves off. This book is for people who want an understanding of how businesses are valued but don’t have the time to read heavy textbooks. 

The book is designed for people who want to learn how to perform valuations themselves. While it doesn’t contain all the details necessary to master the craft of business valuation, it is a great introduction to the topic. 

Our focus is on the valuation of privately held businesses, not publicly traded companies. Public companies can be valued based on their stock prices or various intrinsic valuation models. The value of private and public companies is affected by different factors. 

We hope this book answers questions, provides new insights, and is an enjoyable read. Stay tuned for more details about availability and opportunities to learn more about the content. If you are interested in learning more, please contact Seth Webber or Casey Karlsen.

Article
We wrote the book on business valuation—and it's available now

Read this if you are a Chief Compliance Officer at a broker-dealer.

On August 3, 2022, the Financial Industry Regulatory Authority (FINRA) issued Regulatory Notice 22-18 (the Notice), which addresses the increasing number of reports regarding registered representatives and associated persons (representatives) forging or falsifying customer signatures, and in some cases signatures of colleagues or supervisors, through third-party digital signature platforms. The Notice details multiple FINRA Rules that may be violated in the case of a forgery or falsification and also provides five scenarios member firms reported to FINRA in which representatives forged or falsified customer signatures, including the methods firms used to identify the forgeries or falsifications. The detection methods outlined are:

  • Customer inquiries or complaint investigations
  • Digital signature audit trail reviews
  • Email correspondence reviews
  • Administrative staff inquiries
  • Customer authentication supervision

There is no doubt that digital signatures provide convenience for customers. But this convenience can sometimes lead to unethical or non-compliant behavior. Even situations that representatives believe pass the “straight face” test may be considered non-compliance under FINRA regulations. Member firms should review the Notice carefully and implement some of FINRA’s detection methods, if not already implemented. Some of these methods are likely already in place since they may be duplicative of methods used to satisfy other FINRA Rules. For instance, reviewing customer inquiries or complaints is likely already occurring to satisfy FINRA Rule 4530, Reporting Requirements. As always, if any questions arise, please don’t hesitate to reach out to BerryDunn’s broker-dealer services team.

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Digital signatures: FINRA sends reminder on supervision obligations