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19 essential worker hazard pay FLSA-compliant?

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Colin is a Senior Consultant in BerryDunn’s Government Consulting Group with experience in communicating and executing strategic plans, coordinating membership development for various groups, and managing finance activities. He has worked on a wide range of projects with a focus on programmatic audit, forensic audit, financial process improvement, invoice review, and data analysis. He is a Certified Associate in Project Management and is currently working toward his Project Management Professional® certification.

Colin Buttarazzi
12.23.21

Read this if you used COVID-19 relief funds to pay essential workers.

The Coronavirus Aid, Relief, and Economic Security (CARES) and American Rescue Plan (ARPA) Acts allowed states and local governments to use COVID-19 relief funds to provide premium pay to essential workers. Many states took advantage of this opportunity, giving stipends or hourly rate increases to government and other frontline employees who worked during the pandemic, such as healthcare workers, teachers, correctional officers, and police officers.

States’ initial focus was to get the money to the essential workers as quickly as possible, but these decisions may cause them to be out of compliance with the Fair Labor Standards Act (FLSA), which sets standards for minimum wage, overtime pay, and recordkeeping. As a result, states should review how the funds were disbursed and if payroll adjustments are necessary. The amount, form, and recipients of the pay varied widely from state to state, making determining whether states are compliant with FLSA and calculating any discrepancies an immensely complex task. 

For example, states that disbursed one-time payments to essential workers will likely be able to treat those payments like standard one-time bonuses, while recurring stipends or hourly rate increases should be included in employee’s regular rate when calculating overtime pay. Because this is an unprecedented situation for both states and the federal government, clear guidance is not yet available from the Department of Labor. 

Fortunately, BerryDunn is already working with clients to review their use of the COVID-19 relief funds to help ensure essential workers were paid fairly. Our team is qualified to guide you through your unique situation and help you remain in compliance with FLSA guidelines.

If you have questions about your particular circumstances, please call our Compliance and Risk Management consulting team. We are here to help and happy to discuss options to pay for these services using federal funds.

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Editor’s note: Please read this if you are a not-for-profit board member, CFO, or any other decision maker within a not-for-profit.

In a time where not-for-profit (NFP) organizations struggle with limited resources and a small back office, it is important not to overlook internal audit procedures. Over the years, internal audit departments have been one of the first to be cut when budgets are tight. However, limited resources make these procedures all the more important in safeguarding the organization’s assets. Taking the time to perform strategic internal audit procedures can identify fraud, promote ethical behavior, help to monitor compliance, and identify inefficiencies. All of these lead to a more sustainable, ethical, and efficient organization. 

Internal audit approaches

The internal audit function can take on many different forms, depending on the size of the organization. There are options between the dedicated internal audit department and doing nothing whatsoever. For example:

  • A hybrid approach, where specific procedures are performed by an internal team, with other procedures outsourced. 
  • An ad hoc approach, where the board or management directs the work of a staff member.

The hybrid approach will allow the organization to hire specialists for more technical tasks, such as an in-depth financial analysis or IT risk assessment. It also recognizes internal staff may be best suited to handle certain internal audit functions within their scope of work or breadth of knowledge. This may add costs but allows you to perform these functions otherwise outside of your capacity without adding significant burden to staff. 

The ad hoc approach allows you to begin the work of internal audit, even on a small scale, without the startup time required in outsourcing the work. This approach utilizes internal staff for all functions directed by the board or management. This leads to the ad-hoc approach being more budget friendly as external consultants don’t need to be hired, though you will have to be wary of over burdening your staff.

With proper objectivity and oversight, you can perform these functions internally. To bring the process to your organization, first find a champion for the project (CFO, controller, compliance officer, etc.) to free up staff time and resources in order to perform these tasks and to see the work through to the end. Other steps to take include:

  1. Get the audit/finance committee on board to help communicate the value of the internal audit and review results of the work
  2. Identify specific times of year when these processes are less intrusive and won’t tax staff 
  3. Get involved in the risk management process to help identify where internal audit can best address the most significant risks at the organization
  4. Leverage others who have had success with these processes to improve process and implementation
  5. Create a timeline and maintain accountability for reporting and follow up of corrective actions

Once you have taken these steps, the next thing to look at (for your internal audit process) is a thoughtful and thorough risk assessment. This is key, as the risk assessment will help guide and focus the internal audit work of the organization in regard to what functions to prioritize. Even a targeted risk assessment can help, and an organization of any size can walk through a few transaction cycles (gift receipts or payroll, for example) and identify a step or two in the process that can be strengthened to prevent fraud, waste, and abuse.  

Here are a few examples of internal audit projects we have helped clients with:

  • Payroll analysis—in-depth process mapping of the payroll cycle to identify areas for improvement
  • Health and education facilities performance audit—analysis of various program policies and procedures to optimize for compliance
  • Agreed upon procedures engagement—contract and invoice/timesheet information review to ensure proper contractor selection and compliant billing and invoicing procedures 

Internal audits for companies of all sizes

Regardless of size, your organization can benefit from internal audit functions. Embracing internal audit will help increase organizational resilience and the ability to adapt to change, whether your organization performs internal audit functions internally, outsources them, or a combination of the two. For more information about how your company can benefit from an internal audit, or if you have questions, contact us

Article
Internal audit potential for not-for-profit organizations

Read this if you are responsible for cybersecurity at your organization.

Cybersecurity threats aren’t just increasing in number—they’re also becoming more dangerous and expensive. Cyberattacks affect organizations around the globe, but the most expensive attacks occur in the US, where the average cost of a data breach is $9.44 million, according to IBM’s 2022 Cost of a Data Breach Report. The same report shows that the cost of a breach is $10.10 million in the healthcare industry, $5.97 million in the financial industry, $5.01 million in the pharmaceuticals industry, and $4.97 million in the technology industry.

Cyber threat actors are a serious danger to your company, and your customers, stakeholders, and shareholders know this. They expect you to be prepared to defend against and manage cybersecurity threats. How can you demonstrate your cybersecurity controls are up to par? By obtaining a SOC for cybersecurity report.

What is a SOC for cybersecurity report?

It provides an independent assessment of an organization’s cybersecurity risk management program. Specifically, it determines how effectively the organization’s internal controls monitor, prevent, and address cybersecurity threats.

What’s included in a SOC for cybersecurity report?

The report is made up of three key components:

  1. Management’s description of their cybersecurity risk management program, aligned with a control framework (more on that below) and 19 description criteria laid out by the AICPA.
  2. Management’s assertion that controls are effective to achieve cybersecurity objectives.
  3. Service auditor’s opinion on both management’s description and management’s assertion.

Why should you consider a SOC for cybersecurity report?

A SOC for cybersecurity report offers several important benefits for your organization, which include:

  • Align with evolving regulatory requirements. The cybersecurity regulatory environment is constantly evolving. In particular, the SEC’s cybersecurity guidelines are becoming stricter over time. A SOC for cybersecurity report can demonstrate you’re aligned with these guidelines. If you’re a public company or are considering going public in the future, you need to be prepared to meet not just the SEC’s guidelines of today, but their evolved guidelines in the future.
  • Keep your board of directors informed. Your board is responsible for ensuring the business is effectively addressing and mitigating risks—and that includes cyber risk. A SOC for cybersecurity report offers your board a clear and practical illustration of your organization’s cybersecurity risk management controls.
  • Attract and retain more customers. It’s becoming increasingly common for companies to require that their vendors have a SOC for cybersecurity report. Even for companies that don’t require such a report, it’s important to know their vendors are keeping their data safe. Having this report differentiates you from vendors who have not prepared one.
  • Improve your cybersecurity posture. A SOC for cybersecurity report can identify current gaps in your cybersecurity risk management program. Once you’ve addressed these gaps, you can show your customers, stakeholders, and shareholders that you’re continuously improving and evolving your cybersecurity risk management approach.

How do I prepare for my SOC for cybersecurity assessment?

There are several steps you should take to prepare for your assessment.

  1. Choose your control framework. You have several options, including the NIST Cybersecurity Framework, ISO 27002, and the Secure Controls Framework (SCF). There are multiple online resources to help you choose the framework that’s right for your organization.
  2. Determine who your key internal stakeholders are for your cybersecurity risk management program. You’ll need to select a point person to be responsible for ensuring the independent services auditor has all the documentation they need to complete their assessment and act as liaison across internal and external stakeholders.
  3. Collect all cybersecurity-related documentation in one location. Make sure you have an organizational system that makes sense to your point person so it’s easy for them to pull the appropriate materials to give to the independent services auditor.
  4. Conduct a readiness assessment. You can work with an independent services auditor to conduct such an assessment which will identify gaps you can address before performing the attestation.
  5. Select an independent services auditor to perform the attestation. SOC for cybersecurity services are provided by independent CPAs approved by the AICPA. Ideally, you’ll want to select a firm that is experienced in your industry, has a diverse and robust team of cybersecurity professionals, and is accessible when and where you need them.

As always, if you have questions about your specific situation or would like more information about SOC for cybersecurity services, please contact our IT security experts. We’re here to help.

Article
Yes, you need a SOC for cybersecurity report—here's why

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.

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

Read this if you are a financial institution.

One of the new components to CECL is the consideration of how future economic conditions may impact your estimate of expected losses. What forecasts do you need, how to find and evaluate forecasts, and what are the things you need to think about regarding the forecast choices you make are all excellent questions. Below are 10 things that may help you make, evaluate, and support your “reasonable and supportable” forecast decision:   

  1. Source(s): Even though many understand that economic forecasts, like their weather counterparts, are often wrong, reputation and experience of the forecaster(s) matter. Beyond name recognition, learning more about the people and process of how the forecast is derived will go a long way to helping you defend the source you’ve chosen.  
  2. Types: Forecasts may be produced by an individual, model(s), or group. You may have heard the term “consensus” to describe a forecast—literally, a forecast that results from the majority or average opinion of a group of contributors. An awareness of the type of forecast will help you identify the unique risks of each.    
  3. Assumptions: With any forecast, it is important to understand the specific assumptions on which the forecast is based. “This forecast assumes…,” or “The accuracy of this forecast is contingent upon….,” or “In developing this forecast we relied on….” are just a few examples of what to look for when reviewing introductions, footnotes, or disclaimers to the forecast(s).  
  4. Cost: Fee-based economic forecasts are not inherently more “reasonable and supportable” than free ones; remember, no forecast is perfect. Some fee-based providers may offer a version of their forecast for free. In these cases, having a clear understanding of what’s included in each version may be a deciding factor.
  5. Completeness: The more economic forecasts you read, the more you realize that what they are actually forecasting varies. Evaluating whether or not a forecast is complete is really about discovering if it forecasts all the economic conditions—or economic factors1—that you want to use in your model. For example, you may have mathematically shown that a local or regional unemployment rate is more informative about loss risk in your portfolio, but is there a forecast source for that local or regional rate?
  6. Frequency: Knowing how often a forecast is updated, and when it will be made available is crucial to the timing of your CECL reserve calculation, and the answers may affect more than just your decision of which forecast to use (see “Trade-offs”). For now, consider how reliably and consistently the forecast is available, and if you can count on it with enough time each quarter-end to use it in your reserve calculation.
  7. Future: With all the uncertainty of the past couple of years, it may seem optimistic to think about sources providing more than a one-year forecast. Yet, for some, this may be an important option. For this reason, finding out if a source does, can, or charges extra for providing one-, two-, and three-year (or longer) forecasts may be necessary.  
  8. Bias: It is important to be aware that forecasts can be biased, meaning that they always tend to be more or less enthusiastic about the future. Bias is not the same thing as providing alternative outlooks or scenarios—such as best case/worst case, or neutral/severe, which are more about the assumptions being made. Bias is often detected when over a period of time you compare sources against each other and discover that one source tends to forecast consistently higher or lower than others. This may be especially important when you consider how a forecast does or does not align with the views of the institution’s management.  
  9. Accuracy: Again, since all forecasts will be wrong to some degree, let’s set a new standard for thinking about accuracy. Perhaps the goal here is to find the less-wrong forecast. One way you might want to do this is to locate (or ask for) previous forecasts over different periods of time and compare them to what actually happened. This one is tricky because of assumptions and bias, but if you’ve narrowed it down to a few choices, you may find this kind of exercise helps you decide.
  10. Trade-offs: Given all the forecasting options and considerations, it may be re-assuring to hear that there is no one right answer. But in order to properly support your choices, it is important to think through and document what trade-offs have been made along the way, how they may affect your reserve calculation, and whether or not you feel it should be addressed elsewhere in your methodology.

In closing, two words of caution. First, while having a good single source for a forecast may sound like a great idea, have a back-up plan. Some forecast sources did not produce an update in March-April 2020, the time when first-wave adopters were trying to produce their first quarter CECL estimates, sending some folks scrambling. With this in mind, making use of several forecasts may help you mitigate single-source risk in the long-run. Second, having a process in place to ensure the same economic outlook is being used in all major functions is important. For example, relying on a “severe” future outlook to build loss reserves while at the same time using a “neutral” economic outlook for budgeting and ALM purposes could call into question the reasonableness of your CECL estimate. 

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 consulting 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 managing your CECL adoption, stay tuned for our next article in the series. You can also follow Susan Weber on LinkedIn.

1In this context, economic factors” are measured conditions – such as unemployment, gross national product, consumer price index, etc. 

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Reasonable and supportable forecasts, oh my! 

Read this if you are working on a well-being program at your organization. 

When looking to develop or enhance well-being programs at work, many organizations don’t know where to start. A well-being survey is a smart first step to solidify your organization’s approach to supporting a thriving workforce. An effectively designed well-being survey will not only provide valuable insights to the needs of your workforce, it will also be repeatable so you can measure the success of your well-being efforts over time. Here are five tips to help you create a successful well-being survey.  

  1. Include questions about organizational culture. It is unlikely you will engage every single employee with well-being programs and benefits. Some people just like to do their own thing. However, organizational culture is something that influences everyone and is the ultimate source of empowerment for employee well-being. Including at least a couple of questions that assess how effectively your workplace culture promotes well-being will give you the broadest sense of whether you are on the right track with your well-being efforts. 
  2. Carefully consider wording. There is a big difference between the question “How well does our organization support your well-being?” and “How satisfied are you with our organization’s support for your well-being?” For instance, an organization may invest heavily in mental health, but that support may not be resonating with employees. The second question will provide clear insights into how well the organization’s well-being efforts are connecting with employee needs. 
  3. Have a strategy to promote engagement. Your survey response rate can be influenced by who sends the survey and who sends the survey reminder. While it may be logical for the survey to come from Human Resources, we suggest having the survey come from either the Chief Executive Officer or Chief Operations Officer (or equivalent). This signifies that your organization views well-being as a business strategy. Survey reminders tend to be most effective when sent from department managers. This reinforces the messaging about well-being being a business strategy and signifies commitment at all levels of leadership. 
  4. Include space for open comments. Multiple choice and basic ranking questions can help keep a survey direct and are easy to respond to. They also provide data that is easier to analyze and compare year over year. However, it’s not possible to anticipate every need with multiple choice questions, and some of the best suggestions and ideas, as well as some of the most constructive remarks, will come in the form of open commentary. 
  5. Keep it anonymous but collect some demographic data. An anonymous survey will not only result in more candid feedback, but it will also avoid inadvertently collecting personal health information that may be disclosed (particularly in open comments). Having optional questions to self-identify department, office, or work arrangement (hybrid, remote, in person) can help identify high-risk groups ('high risk' meaning those who have a low perception of their well-being and the organizational culture). Making these questions optional reduces the risk that an employee will abandon the survey due to fear of being identified based on demographic responses (e.g., an employee who is the only remote employee in their department). 

A well-designed well-being survey can serve as a launchpad for a transformational well-being initiative, especially if your organization is prepared to report and act on results. For more information on how your organization can create and deliver a well-being survey, or if you have other well-being program questions specific to your organization, please contact our Well-being consulting team. We’re here to help.

Article
Five tips for employee well-being surveys that work

Read this if you are a financial institution.

Have you ever noticed how a countdown seems to want to pick up speed the closer you get to the finish? 10, 9, 8… The chanting gets louder, and excitement builds with each passing number: 7, 6, 5… For me, the adrenaline really kicks in below 5: at 4, 3, 2.

Whether it’s excitement or anxiousness you’re feeling as CECL adoption approaches, staying focused on the remaining decisions is vital to your success. One of those decisions—and a frequently asked question in recent discussions with 2023 adopters—is about implementing Q factors (qualitative adjustments). So let’s take a look at some key considerations for Q factors.

10, 9, 8…

The role and nature of Q factors are to adjust for certain things you know or think will be different about losses in the future than they were in the past. They are also intended to be transitory. Like a scientific hypothesis, each Q factor adjustment exists until it bears out and is picked up in your primary model output, or it doesn’t. Either way, the need for that particular adjustment would presumably end. The one adjustment that most often comes to mind is economic forecasts, a new component of CECL. Let’s assume you have a qualitative adjustment for an expected upcoming recession—depending on your chosen method, for instance, the difference in reserve calculated when using a more severe economic scenario, or using historical losses only from a time period that was recessionary. Regardless, one would not expect this to be a permanently held adjustment—at some point, the recession happens, or it does not, and the adjustment may no longer be warranted. Categories of Q factors give us a place to start thinking through what specifically is different or what is changing, whether it is something broad, like economic forecasts, or something specific like new products or geographies in which you lend money. The key here is that it is something not accounted for already in the design, structure, inputs, or output of your core model.1  

7, 6, 5…

Effectively implementing Q factors requires you understand how your segmentation (pools for collective analysis) and method selection affect your opportunity to make and support adjustments. What does this mean? 

Segmentation under CECL requires grouping loans based on similar risk characteristics. This is inherently about behavior that has to do with risk and loss. Grouping all first lien residential mortgage loans together is a common one. If you have a big enough portfolio with enough historical loss history to support it, you may be able to further sub-segment that pool by geography (region, state, county), or by nature of use (primary residence, vacation home, or investment property), or by collateral lien position (first lien, junior lien). You’d want to do this if the inherent risk of loss you face is different. This loss risk difference could be a matter of customer behavior, or a difference in market conditions.

But what if, through the model development stage, you realize (or are told) that you don’t have enough data or big enough pools to model effectively at your preferred level of segmentation? Or, what if the method you chose comes with a level of segmentation already built-in?

4, 3, 2…

Let’s stick with residential mortgages. If you’ve accepted a higher level of segmentation, for example at the product level (residential mortgages) or even higher at the call report code level (1c), you may be thinking you have lots of leeway to make qualitative adjustments for all the nuances underneath. Not so fast. Are there any other modelling choices you’ve made that may prevent you from doing that? What about the use external loan data?

A common modeling technique is to use peer data to help establish the mathematical relationship between historical losses and changes in the economy. Most peer data is only available at the call report code level, which means that all those nuances in your “1c segment” that you want to further adjust may already be embedded in your methodology because of the connection to peer data. This may be even further complicated by situations in which you have no say in more proprietary loan data sets model developers may be using to support their model design, assumptions, and formulas. External loan pool data is just one of many things to consider when evaluating when, and if there are opportunities to support a Q factor adjustment.

So what’s a responsible CECL adopter to do when considering how best to make qualitative adjustments? 

First, understand that the intention is to account for changes and differences, which inevitably is a moving target. Adjustments and their related reserve dollars are not fixed, which is why they should be subject to re-assessment each time you update your CECL calculation. Second, if you’re using a vendor’s model, it is imperative that you know how, when, and to what extent loan data other than yours is or has been used, both in developing the model and in its on-going operation. Third, you need to understand, document, and think through the interplay between the segmentation you have and model design or other assumptions made along the way. Finally, if in the normal course of operation, you change any of those assumptions or inputs, it should trigger a re-evaluation of your Q factors to ensure they remain relevant. 

Want help with your Q Factor approach? Are you struggling with CECL documentation or other elements of CECL? 

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 consulting 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.

1If you haven’t already, I highly recommend that you read these sections of the accounting standards codification (ASC) 326, commonly referred to as the CECL standard: 326-20-55-4, 326-20-30-7, 326-20-30-8, and 326-20-30-9.

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Implementing Q factors under CECL: Why your segmentation and other modeling choices matter

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

Our annual not-for-profit Recharge event provides attendees with an opportunity to hear about hot button issues in the not-for-profit industry. We polled registrants from across the country to see where they are focusing their attention in the current landscape. 

Employee retention

Overwhelmingly, employee retention is a number one concern for organizations, with 78% of respondents saying they were strongly focused on it in 2022. Not surprisingly, financial stability (67%), cybersecurity (50%) and concerns about access to government funding (43%) were of common concern among respondents.


 
Remarkably, employee retention in 2022 weighed more heavily on respondents than concerns around the remote workplace in 2021. While over 57% of respondents were concerned about the remote workforce in 2021, employee retention did not even make it into the top four concerns for organizations. This shift is consistent with what we are seeing in our client base, as organizations embraced hybrid and remote working arrangements and are well into codification of and adherence to the policies in place. Organizations reported taking significant efforts toward employee retention, most commonly looking at increasing salaries and allowing hybrid and flexible work arrangements as methods to help retain employees.

Financial stability

The concern around financial stability is slowly starting to decline. While financial stability was a top concern for 83% of organizations in 2021, that percentage dropped to 67% of respondents listing it as a top concern in 2022, While multiple factors certainly contribute to these results (availability of COVID relief funds, for example), the decline is significant, especially in this time of inflationary growth and demands on the labor market. This decline may be reflective of the continued transition away from short-term emergency response and toward a more future-oriented mindset. 

Other concerns

Both cybersecurity and government funding concerns held relatively steady in 2022 compared to 2021, with 45% of respondents concerned with cybersecurity and government funding in 2021, compared to 50% and 43% in 2022, respectively. 

Participants also reflected on the perceived top concerns for their board members, with employee retention and recruitment and overall financial stability leading in top importance. These mirrored concerns are of no surprise, but speak to the continued need for regular and reliable reporting to boards to allow for continued rapid response by those charged with governance.

If you have any questions about your specific concerns or situation, please don’t hesitate to contact our not-for-profit team. We’re here to help.

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Employee retention and other concerns: NFP outlook for the year ahead