A Deeper Dive Into ASU 2016-14 Implementation Issues – Part Two

By Tammy Ricciardella, CPA

In this issue, we will examine two additional areas of the ASU: Expense reporting and reclassification upon expiration of donor-imposed restrictions.

Expense Reporting

Once ASU 2016-14 is adopted, all nonprofits are required to present expenses by nature and by function, as well as an analysis of these expenses in one location by both nature and function. This analysis can be presented on the face of the statement of activities, as a separate statement (not a supplemental schedule) or in the notes to the financial statements.

As a quick refresher, functional expense classifications are generally shown as:

  • Program services: Activities that result in goods and services being distributed to beneficiaries, customers or members that fulfill the purposes or mission for which a nonprofit exists
  • Supporting services, which often include:
    • Management and general: Activities generally include oversight of the nonprofit and financial management
    • Fundraising: Activities undertaken to induce potential donors to contribute to the organization
    • Membership development: Activities undertaken to solicit new members and retain existing members

The ASU has modified the definition of management and general activities. The revised definition is “supporting activities that are not directly identifiable with one or more program, fundraising or membership development activities.” Thus, activities that represent direct conduct or direct supervision of program or other supporting activities require allocation from management and general activities. Additionally, certain costs benefit more than one function and, therefore, should be allocated. For example, information technology generally can be identified as benefiting various functions such as management and general (for example, accounting, financial reporting and human resources), fundraising and programs. Therefore, information technology costs generally would be allocated among functions receiving direct benefit.

The expense analysis required by ASU 2016-14 should show the disaggregated functional expense classifications, such as program services and supporting activities by their natural expense classification, such as salaries, rent, depreciation, interest, professional fees and such.

If there are expenses that are reported by a classification other than their natural classification, such as when a nonprofit shows costs of goods sold and includes salaries in this presentation, these expenses should still be segregated and shown in the analysis by their natural classification within each function.

However, the external and direct internal investment expenses that are netted against investment return (as required by the ASU) should not be included in this analysis of expenses by nature and function.

In addition, gains and losses incurred by the nonprofit on such items as a loss on the sale of equipment or an insurance loss or gain should not be shown in this analysis of expenses.

It is also important to note that the ASU does not change any current generally accepted accounting principles (GAAP) related to the allocation, reporting and disclosures of joint costs.

The expense analysis presented is required to be supplemented with enhanced disclosures about the allocation methods used to allocate costs among the functions. In developing this disclosure, a nonprofit should assess which activities constitute direct conduct or direct supervision of a program or supporting function, and, therefore require an allocation of costs. An example of a disclosure regarding the allocation of costs is provided below (this is an excerpt from the ASU at section 958‑720-55-176):

Note X. Methods Used for Allocation of Expenses from Management and General Activities

The financial statements report certain categories of expenses that are attributable to one or more program or supporting functions of the Organization. Those expenses include depreciation and amortization, the president’s office, communications department and information technology department. Depreciation is allocated based on square footage, the president’s office is allocated based on estimates of time and effort, certain costs of the communications department are allocated based on estimates of time and effort, and the information technology department is allocated based on estimates of time and costs of specific technology utilized.

The revised ASU provides specific examples of direct conduct and supervision as it relates to the determination of certain types of expenses. These are contained at sections 958-720-55-171 through 958-720-55-176 in the ASU. The ASU provides examples of allocations of a chief executive officer, chief financial officer, human resources department and the grant accounting and reporting function. In these sections it notes that the cost of the human resource department is not generally allocated to any specific program, and that instead all costs would remain as a component of management and general activities because benefits administration is a supporting activity of the entire entity.

Nonprofits should review the clarifications in the ASU with regard to the allocation of expenses and review their allocation methodologies to determine if there are any changes that are necessary. Once the organization determines the correct allocation approach, they will need to decide where they want to present this analysis in their financial statements and develop the format. Some organizations may also need to evaluate the different programs and supporting activities they have historically presented to determine if the presentation is concise. In addition, the organization will have to develop the wording for its allocation methodology disclosure.

Reclassification upon Expiration of Donor-Imposed Restrictions

If a nonprofit has received funds restricted to the purchase or construction of property, plant or equipment or a donation of such an asset with an explicit donor-imposed restriction on the length of time that the asset must be used, then net assets with donor restrictions should be reclassified as net assets without donor restrictions in the statement of activities as the restriction expires. The amount that is reclassified may or may not be the same as the amount of depreciation recorded on the asset. The amount reclassified each year should be based on the length of time of the explicit time restriction for the use of the asset. However, the depreciation should be based on the useful economic life of the asset.

If the donor does not specify how long the donated assets or assets constructed or acquired with cash restricted for the acquisition or construction must be used, then the restrictions on the long-lived assets, if any, expire when the assets are placed in service.

The entire amount of the contribution of property, plant or equipment, or cash shall be reclassified from net assets with donor restrictions to net assets without donor restrictions when the asset is placed in service if there are no explicit restrictions noted by the donor with regard to how long the long-lived asset is to be used.

When examining the effect of the ASU on your organization you should look at whether you have any contributions of long-lived assets that are being reclassified over time without any explicit stipulation of a time period for the use of the asset. If these assets have already been placed in service, the amount of these long-lived assets should be reclassified from net assets with donor restrictions to net assets without donor restrictions upon adoption of the ASU.

In addition, the organization will have to modify its policy with regard to the receipt of contributions for the construction of long-lived assets or donated long-lived assets. Upon adoption of the ASU, an organization will have to recognize revenue without donor restrictions when the donated assets are placed in service absent any explicit donor stipulations otherwise. In the past, organizations had an option to either follow the placed-in-service approach or to place an implied time restriction on the long-lived assets.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

Automation In Manufacturing & Distribution: Are Job Cuts The Future?

By Rick Schreiber

We’re at the onset of the next big industrial revolution—and the widespread adoption of new technologies, including Internet-connected devices, machine learning and robotics in the manufacturing industry. Strides in automation have significantly boosted U.S. manufacturers’ output in recent years, and the industry is just beginning to understand and exploit the full potential of technology and disruptive supply chain models to reinvent manufacturing as we know it.

And the future of American manufacturing jobs at the end of this evolution? They’re going to look very different.

The new administration is focused on American jobs lost to offshoring and relatively cheap foreign labor, but over the long run, automation technologies are set to replace far more U.S. manufacturing positions. The new Treasury Secretary Steven Mnuchin isn’t concerned, and was recently quoted saying, “I think that is so far in the future […] I think we’re, like, so far away from that that. [It’s] not even on my radar screen.”

But we’re already seeing it happen. A report from Ball State University found between 2006 and 2013, trade accounted for just 13 percent of lost U.S. factory jobs, while the vast majority of the lost jobs were taken by robots and other domestic factors. But in the same breath that we talk about the elimination of manufacturing and distribution positions, we also talk about a shortage in technology talent. The reality is companies are hiring—but they’re hiring for different skillsets than they were even five years ago. Today’s—and tomorrow’s—advanced manufacturing jobs demand a greater emphasis on technological savvy, ingenuity and engineering skills that can’t be replicated by a machine—yet.

At the same time, public perception of manufacturers’ staffing decisions is changing, triggered by recent high-profile negotiations between manufacturers and the government. The unprecedented use of the Twitter “bully pulpit” to influence corporate decision-making could change the way companies approach and communicate about staffing. The balancing act between reputation management and the need to compete effectively in a global economy could grow more delicate. Still, while layoffs and closures, like those underway at several prominent Indiana factories that plan to move production to Mexico, are front and center in the nation’s collective attention, there are fundamental and permanent changes altering the nature and core capabilities of manufacturing and distribution jobs that have nothing to do with location or immigration status.

On the distribution side, several autonomous vehicle startups are targeting the trucking industry, which they see as ripe for disruption, according to The Wall Street Journal. While the application of autonomous technology into everyday cars for consumer use is drawing far more attention and hype, artificial intelligence experts believe the technology could master highways before city streets. The trucking industry faces a shortage of experienced, safe drivers, as well as heightening regulation limiting the hours those drivers can work in a day. If automation can increase the speed and efficiency with which products can travel and enhance roadway safety, it could be a boon to the industry. However, it’s worth noting this progress is not without setbacks and challenges. Additional technological advancements will be needed to address safety concerns critical to market acceptance of these technologies before car or truck automation goes commercial.

In sectors serving the food and consumer products, we’re seeing many manufacturers reevaluate their distribution models as consumer shopping habits change. Simultaneously, pressures to reduce operating expenses have increased. As a result, those industries are moving from direct store to centralized distribution and real-time inventory management, which allows order points to be less tied to warehouse inventory levels and more responsive to demand.

Not only does this enable companies to cut logistics costs and take advantage of efficiencies of scale, but they can also better compete with e-commerce retailers, online grocers and other alternatives that offer customers more choices, faster than ever before. Today’s retail and manufacturing customers have little tolerance for delayed or incorrect orders, meaning logistics and distribution—from warehousing to order fulfillment to shipping—must happen at lightning speed and be resilient in the face of disruption. If automation can increase speed and reduce costs, while also maintaining order accuracy and quality control, it’s a win-win for manufacturers and their customers. But these optimization strategies may result in closing factories that have been rendered obsolete, leaving the employees who work there in job limbo.

While staffing changes and layoffs may be par for the course during these transitions, long-term cost savings will ultimately come from increased productivity and greater operating efficiencies, which can be driven by a variety of factors. In fact, some of the companies that have been most successful at implementing process improvements have done so without significant layoffs. As the manufacturing industry takes the training wheels off new technologies, certain staffing strategies will remain consistent in ensuring profitability and competitiveness: Implementing and maintaining lean manufacturing principles, minimizing costly labor turnover and selecting staff with the right core capabilities will remain among the most important considerations.

The traditional factory job might be disappearing, but ultimately, greater productivity and lower costs translate into higher profit margins, resulting in more manufacturing jobs, not fewer.

This article originally appeared in BDO USA, LLP’s “Manufacturing Output” newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com


PErspective in Real Estate

A feature examining the role of private equity in the real estate sector.

REITs, Private Equity Look Beyond Core Properties in 2017

Private equity (PE) fund managers are growing bullish on the real estate industry. PE funds have already raised a combined $237 billion globally to invest in commercial real estate in 2017, outpacing the 2016 total of $202 billion, according to Preqin. With the Federal Reserve expected to introduce at least three interest rate increases in the year ahead, returns on real estate investments may decline. Investors face steeper competition for office, hotel and multi-family properties, and the dip in returns could lead many fund managers to embrace alternative real estate assets. REITs and private equity real estate funds are already sharpening their focus on non-traditional real estate assets.

Single-family rentals (SFR) is one niche area that has already shown hints of growth in 2017. In a deal that created the largest SFR REIT to date, private equity giant Blackstone raised $1.54 billion in a January IPO of its SFR portfolio, Invitation Homes. As of mid-February, the shares were trading at $20.88. PE and REIT interest in SFR took off during the housing crisis, with both investment vehicles buying up distressed homes. According to Hoya Capital Real Estate, the SFR sector performed well in 2016, with a 26 percent rate of return. Now that the housing market has stabilized, more fund managers are looking to exit and the momentum is likely to continue, perhaps with activity from strategic buyers picking up.

Another attractive investment option is data warehouses. The explosion of wireless connectivity, cloud computing and data has led to more demand for storage space. An IDC study found the total amount of stored data is doubling approximately every two years. Data warehouses or data centers are one way investors can capitalize on the network of facilities sustaining the growth of the Internet of Things. This year, data center acquisitions amounted to $1.7 billion, and investment activity is forecast to ramp up in 2017. Data Center REIT Equinix’s $3.6 billion deal to acquire Verizon’s data center businesses, which include 24 facilities, is expected to close in mid-2017.

Although PE interest in real estate is expected to increase, the bulk of investments this year will likely stem from the larger players. Carlyle Group is in the early stage of raising $5 billion for its eighth real estate fund. Consistent with the sector-wide trend, Carlyle Group plans to focus on niche property types with this fund—specifically, senior housing investments and rental properties.

In addition to increased investment in niche properties, private equity has also moved into the debt financing space. Private equity firms and other non-bank lenders are increasingly raising debt funds, providing loans as an alternative to or in conjunction with traditional banks for construction projects and property renovations. Investing in real estate debt could become a more prevalent strategy for PE firms as interest rates rise.

While PE consistently attracts interest from institutional investors, pension and endowment fund managers have historically had some concerns with REITs’ volatility and ties to the stock market. But as real estate investing becomes more common, some institutional investors have started to take a closer look at REITs. South Carolina Retirement System Investment Commission, for example, made its first investment in REITs in 2016 by allocating about $728 million. As the types of investors funneling capital into PE and REITs converge, REIT fund managers would be wise to watch how PE interest develops in the sector and how it could spur more competition for assets.

Future PErspectives: What’s Next for Real Estate Investors?

In response to President Donald Trump’s pledge to invest heavily in nationwide infrastructure initiatives, PE and REITs are unsurprisingly bullish on infrastructure. In the president’s first week in office alone, his administration announced infrastructure projects totaling more than $137.5 billion.

As PE and sovereign wealth funds explore adding infrastructure assets to their portfolio, we may see them leverage public-private partnerships (P3s). Through P3s, private sector companies partner with government agencies to finance and implement some or all aspects of public projects, including infrastructure, such as transportation and municipal buildings. Already in 2017, the Los Angeles County Metrorail is reportedly considering leveraging P3s to fast-track a transportation initiative.

Fiscal stimulus, such as investment in infrastructure, is likely to drive economic growth and reflect positively upon real estate fundamentals. While the full extent of the new administration’s infrastructure priorities has yet to take shape, the real estate industry is keeping a close eye on opportunities as they evolve.

This article originally appeared in BDO USA, LLP’s “Construction Monitor Newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

Accounting and Financial Reporting for Other Postemployment Benefit Plans

By Patricia Duperron, CPA

Beginning with fiscal years ending June 30, 2017, the first of the two Other Postemployment Benefit (OPEB) standards from the Governmental Accounting Standards Board (GASB) becomes effective.

GASB Statement No. 74, Financial Reporting for Postemployment Benefit Plans Other Than Pension Plans replaces GASB Statements Nos. 43 and 57 for reporting of OPEB plans and mirrors the requirements of GASB Statement No. 67, Financial Reporting for Pension Plans. The good news is that most everything you learned in implementing the pension standards will apply to implementing the OPEB standards. There are, however, a few exceptions which will be discussed herein.

OPEB includes postemployment healthcare benefits such as medical, dental and vision, whether the benefit is provided separately from or through a pension plan. However other benefits, such as death benefits, life insurance, disability and long-term care are considered OPEB, subject to GASB 74 only when provided separately from a pension plan. OPEB does not include termination benefits or termination payments for sick leave.

GASB 74 applies to defined benefit plans and defined contribution plans administered through trusts, as well as plans not held in trust. Similar to pension plans, there are three types of defined benefit OPEB plans:

  • Single-employer
  • Cost sharing multiple-employer—in which the OPEB obligations to the employees of more than one employer are pooled and OPEB plan assets can be used to pay the benefits of the employees of any employer that provides pensions through the plan.
  • Agent multiple-employer plans—in which OPEB assets are pooled for investment purposes but separate accounts are maintained for each individual employer so that each employer’s share of the pooled assets is legally available to pay the benefits of only its employees.

GASB 74 does not apply to insured plans (those financed through an arrangement whereby premiums are paid to an insurance company during employees’ active service and the insurance company unconditionally undertakes an obligation to pay the OPEB of those employees).

GASB 74 requires the same two financial statements currently required by GASB 43 for plans administered through trust:

  • Statement of fiduciary net position (similar to GASB 67, receivables for contributions are only included if due pursuant to legal requirements)
  • Statement of changes in fiduciary net position
  • Footnotes specified by paragraph 35 of GASB 74 should include:
  • Basic description of the plan and policies
  • Investment information, including the annual money weighted rate of return
  • Information about reserves
  • Single and cost-sharing plans should also disclose:

–  Components of the OPEB liability

–  Significant assumptions

–  Healthcare cost trend analysis

–  Discount rate

–  Long-term expected rate of return

–  Sensitivity analysis of the discount rate and the healthcare cost trend rate

Note that the sensitivity analysis for OPEB includes the healthcare cost trend rate, which is something that wasn’t required for pension plan financial statements. The net OPEB liability will be shown at the current healthcare cost trend rate and one percentage point higher and lower. The discussion of actuarial assumptions will also include the healthcare cost trend rates.

Required supplementary information (RSI) for single and cost-sharing employers should include 10-year schedules of:

  • Changes in the OPEB liability and related key ratios
  • Actuarially determined contributions and actual contributions
  • Annual money-weighted rate of return on investments
  • Notes to the required schedules

RSI for agent OPEB plans requires a 10-year schedule of the annual money-weighted rate of return.

The OPEB liability should be determined by an actuarial valuation which can be no more than 24 months earlier than the plan’s most recent year-end, using the entry age actuarial cost method. The discount rate should be a single rate that reflects the long-term rate of return on investments that will be used to pay benefits. If there will be insufficient assets to pay the liability, the index rate for 20-year tax-exempt municipal bonds with an average rating of AA/Aa or higher would be used. Keep in mind that actuaries will be quite busy as everyone will be required to get OPEB valuations completed this year, so don’t wait until the last minute.

For assets accumulated to provide OPEB but not in a trust, the employer will continue to report the assets in an agency fund. For defined contribution plans there are specific disclosures required.

GASB has issued an Exposure Draft Implementation Guide No. 201X-X, Financial Reporting for Postemployment Benefit Plans other than Pension Plans, which follows the format of the GASB 67 Implementation Guide. The Implementation Guide includes illustrations to assist in determining the discount rate, money-weighted rate of return and sample note disclosures and should be finalized in April 2017.

Deferred inflows and deferred outflows of resources should be fairly rare as GASB has not identified any deferrals specific to OPEB. The draft Implementation Guide identifies a possible deferred outflow or deferred inflow related to derivatives, if applicable.

Implementing GASB 74 for OPEB plan financial statements will be very similar to the implementation of GASB 67 for pension plans. The GASB intentionally made GASB 74 similar to GASB 67 to minimize implementation issues for governments. However, in 2018 governments will be required to implement GASB statement No.75, Accounting and Financial Reporting for Postemployment Benefits Other than Pensions, which will require governments to record their proportionate share of the net OPEB liability in the financial statements. Previously, governments only recorded an OPEB obligation if they didn’t fully fund the annual required contribution and the net OPEB liability was only disclosed in the notes. Implementing GASB 75 will have a significant effect on a government’s net position because many OPEB plans are significantly underfunded or not funded at all.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

Public Charities and Private Foundations—What’s the Difference?

By Christina K. Patten

When starting a 501(c)(3) organization, the IRS will generally classify it one of two ways—either as a public charity or a private foundation. Public charities are known to perform charitable work, while private foundations are typically grant-making organizations. The main difference between public charities and private foundations is the source of their financial support.

Public Charities

Public charities generally have greater interaction with the public and receive the majority of their financial support from the general public and/or governmental units. Organizations such as churches and religious organizations, schools, hospitals and medical research organizations automatically qualify as public charities while other organizations must prove to the IRS that they are publicly supported.

An organization is considered publicly supported if:

  1. It normally receives one-third of its support from a governmental unit or from contributions from the general public or at least 10 percent public support, and facts and circumstances that show the public nature of the organization; or,
  2. It normally receives more than one-third of its support from gifts, grants, contributions or gross receipts from activities related to its exempt purposes, and not more than one-third of its support from gross investment income.

An organization can also achieve public charity status if it is a supporting organization of another charity that derives its public charity status under one of the tests stated above.

The IRS will automatically presume an organization to be a private foundation unless it can show that it is a public charity. After an organization’s initial five years, its public support test is based on a five-year computation period that consists of the current year and the four years immediately preceding the current year.

Private Foundations

A private foundation is typically controlled by members of a family or by a corporation, and receives much of its support from a few sources and from investment income. Because they are less open to public scrutiny, private foundations are subject to various operating restrictions and to excise taxes for failure to comply with those restrictions.

The IRS recognizes two types of private foundations: Private non-operating foundations and private operating foundations. The key difference between the two is how each distributes its income: A private non-operating foundation grants money to other charitable organizations, while a private operating foundation distributes funds to its own programs that exist for charitable purposes.

Benefits of Public Charities Over Private Foundations

Classification is important because private foundations are subject to strict operating rules and regulations that do not apply to public charities. Some advantages public charities have over private foundations include higher donor tax-deductible giving limits, 50 percent of adjusted gross income (AGI) versus a private foundation’s 30 percent of AGI limit, and the ability to attract support from private foundations. Public charities also have three possible tax filing requirements based upon annual revenue: Form 990 (> $200,000), Form 990-EZ ($50,000 – $200,000), and Form 990-N e-postcard (<$50,000). All private foundations, regardless of revenue, must annually file Form 990-PF. Additionally, a private foundation must annually distribute at least 5 percent of the fair market value of its net investment assets for charitable purposes. The penalty for failure to meet the 5 percent required minimum distribution is 30 percent of the shortfall or the remaining amount that should have been spent to meet the required minimum level. Private foundations are also subject to strict self-dealing rules, a 1 percent or 2 percent tax on investment income and certain expenditure responsibilities.

Public charities may engage in limited amounts of direct and grassroots lobbying. Private foundations that spend money on lobbying will incur an excise tax on those expenditures; this tax is so significant that it generally acts as a lobbying prohibition.


When deciding whether to operate as a public charity or a private foundation, the decision should depend on the organization’s programs and objectives. Once an organization is classified as a public charity, it must demonstrate annually that it meets the public charity tests. Once an organization is classified as a private foundation, it remains a private foundation.

If an organization fails the public support test two years in a row, it is at risk of reclassification as a private foundation, which can have significant implications for sustainability and mission accomplishment. To regain status as a public charity, the organization must notify the IRS in advance that it intends to make a qualifying 60-month termination. Only if it meets one of the public support tests at the end of a 60-month (five-year) period can the organization again operate as a public charity.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Spring 2017). Copyright © 2016 BDO USA, LLP. All rights reserved. www.bdo.com

Effects of Potential Tax Reform on the Real Estate Industry

By Sean Brennan

Now that the dust of a contentious presidential election cycle is settling, tax reform may be more likely in 2017 than in past years. There are currently two plans we can look to for guidance on reform: President Donald Trump’s revised plan and the House GOP plan. Both contain significant reductions in individual and corporate tax rates, limitations on deductions and simplification of administration of the tax system. While the plans are summaries of proposed tax reform and give us a basic understanding of their intentions, neither plan answers all our questions concerning implementation for taxpayers.

Provisions of each proposal may affect the real estate industry in the long term, including the current write-off of acquired property, limitations on the deductibility of interest expense and the overall reduction of tax rates.

Tax Rate Reduction

Arguably the most important potential tax reform for both individuals and corporations is tax rate reduction. The president’s and the House GOP tax reform plans both call for significant tax rate reduction for both individuals and corporations. The two plans call for reduced corporate tax rates of 15 percent and 20 percent, respectively. Under the president’s plan, business income earned by pass-through entities would also be taxed at a 15 percent rate. Under the House GOP plan, income from pass-through entities would be taxed at a maximum rate of 25 percent. It’s not clear whether income from rental real estate would qualify as “business income” under the president’s plan. Both plans call for a repeal of the corporate alternative minimum tax (AMT).

To reduce business tax rates, the president’s plan calls for the elimination of most business deductions and credits, except the federal R&D credit. The House GOP plan also calls for reducing business deductions, including the deduction for interest expense in excess of interest income. However, there is a proposal under the House GOP plan to allow immediate write-off of investment of both tangible and intangible assets, including property.

Carried Interest

The president’s plan proposes altering the tax treatment of carried interest. Carried interests are commonly used when forming a real estate development partnership to compensate a promoter for services rendered to the partnership with an interest in the partnership. Ultimately, the promoter can be taxed using favorable capital gains tax rates. If carried interest taxation rules are changed, promoters may be required to pay taxes on receipt of carried interests using ordinary tax rates.

Property Depreciation

The last rewrite of the Internal Revenue Code (IRC) in 1986 extended depreciable lives for commercial real estate from 19 years to 31 years. Depreciable lives now are set at 39 years for most properties acquired in 2017. As mentioned above, the House GOP plan includes immediate expensing of all acquisitions of tangible and intangible property. Therefore, commercial buildings and other real estate development would be fully written off in the year acquired or placed in service. A similar provision is included in the president’s revised plan, which proposes full expensing of plant and equipment for manufacturers. But the plans also call for the elimination of deductions for net interest expense on debt. Thus, interest expense deductions would be disallowed to the extent they exceed the taxpayer’s interest income. Taxpayers would have to weigh the benefits of the simplification of an immediate write-off of newly acquired property against the loss of tax deductions for interest on the debt used to acquire the asset. Net operating losses resulting from the immediate expensing of commercial real estate would be able to be carried forward indefinitely, with no carryback allowed.

Mortgage Interest Deduction

Currently, mortgage interest payments for acquisition debt up to $1 million and $100,000 in home equity debt are deductible. The president’s plan calls for limitations or phaseouts of itemized deductions at $100,000 for single filers and $200,000 for married filers. The House GOP plan calls for the elimination of nearly all deductions except the mortgage interest deduction and charitable contribution deduction.

Alternative Minimum Tax/Net Investment Income Tax

Under both the president’s plan and the House GOP plan, AMT and the net investment income tax (3.8 percent on net investment income) would be repealed.

Looking ahead: We’ll be watching

While it is very early in the process of rewriting the IRC, the prospects of reform continue to grow stronger with a Republican White House and Republican control of the House and Senate. Real estate companies can review potential reforms now to prepare for scenarios that could be ahead. We will continue to monitor these preliminary tax reform plans, as well as others that may arise, in the coming months as the process unfolds.

This article originally appeared in BDO USA, LLP’s “Construction Monitor Newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

PErspective in Manufacturing

A feature examining the role of private equity in the manufacturing sector.

The new administration’s pro-economic growth agenda has spurred optimism among the investment community, and most agree the coming year is primed for a healthy cadence of deals.

In fact, in a poll BDO conducted in January, 71 percent of fund managers characterized the investment environment as favorable. That represented a 15 percentage point jump from managers who said the same prior to the November election results (56 percent).

While the industry continues to barrel toward innovation, traditional manufacturers of components and parts for a variety of applications—including industrial application and consumer products—continue to garner interest from private equity and strategic buyers. With trade policy front and center and, if proposals aimed at fortifying domestic manufacturing come to fruition, companies in the sector could be poised to see a much bigger influx in private equity investment.

Given the private nature of most transactions, it is difficult to say whether the following proved to generate good returns for the sellers or smart investments for the buyers, but here are a few transactions that characterize the pace and breadth of activity in recent weeks:

In a deal announced Jan. 4, Graham Partners sold blow molder Western Industries to Michigan-based Speyside Equity Fund. Terms of the deal were not disclosed, reports Plastics News. Speyside, a 12-year-old fund, targets manufacturing businesses in specialty chemicals, food and metal-forming, among others. Western Industries’ plastics unit, which the company says is home to one of North America’s biggest collections of plastic presses, specializes in large and complex plastics products and components for industrial and consumer end-markets. They also offer assembly, packaging and logistics services.

Gladstone Investment Corporation, a publicly traded business development firm that makes debt and equity investments, has announced plans to sell its equity interest and the prepayment of its debt investment in Behrens Manufacturing to Mill City Capital, a producer of branded metal containers. Gladstone, which acquired Behrens in 2013, has seen its shares rally six percent since that announcement on Dec. 19.

Bain Capital Private Equity, meanwhile, has announced it will buy Innocor Inc. from Sun Capital Partners Inc. in a deal set to close in the first quarter of this year, according to The Middle Market. Innocor, a New Jersey-based manufacturer of polyurethane foam products and home furnishings, owns 22 plants and distribution centers across the U.S. The Middle Market reports that home furnishings manufacturers are the beneficiaries of increased demand tied to an uptick in new home sales. Z Capital Partners’ investment in Twin-Star International and Mattress Firm Holding Corp.’s deal with Sleepy’s are two examples of buyer interest driving deals in this space.

In the food sector, PE Hub reports Charlesbank Capital Partners announced in January the sale of food manufacturer and packaging and supply chain management provider Peacock Foods to Greencore Group plc, an Ireland-based convenience foods producer. Illinois-based Charlesbank focuses on companies in the automation, packaging and processing subsector. The firm operates seven manufacturing facilities.

In December, Platinum Equity completed the acquisition of two Asia-based manufacturing enterprises: Foam Plastics Solutions, a leading maker of protective packaging; and Flow Control Devices, a manufacturer of valves, fittings, sensors and other components, reports PE Hub. The Trump administration’s focus on reshoring American manufacturing, however, could dampen interest in foreign manufacturers in the coming months. This will be a trend for domestic manufacturers to watch as it could add to buy-side demand and drive up valuations for U.S. manufacturing firms.

Future PErspectives: What’s Up Next for Manufacturing Investors

In light of uncertainty around U.S. global trade policy under the new administration, we could see technology companies in particular begin expanding U.S. manufacturing operations, according to Business Insider. For example, Nikkei reports that Japanese manufacturer Sharp, owned by Foxconn—Apple’s top manufacturing partner—is mulling a screen factory in the U.S. Foxconn is an investor in Softbank’s Vision Fund, which insiders report could be leveraged to purchase technology assets or make a private equity deal. U.S.-based factories may be subject to increased costs due to higher labor costs and reliance on Asian parts suppliers. If tech darling Apple begins increasing its manufacturing footprint in the U.S., other companies could follow suit. This trend would likely lead to more private equity dollars investing in the domestic technology sector.

Sources: PE Hub, Benchmark Monitor, Plastics News, Pittsburgh Business Times, The Middle Market, Business Insider, Nikkei

This article originally appeared in BDO USA, LLP’s “Manufacturing Output” newsletter (Winter 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

REIT IPO Watch: 2017 Progress Report

By Brent Horak

After IPO activity slowed to a trickle in 2016, the capital markets community projects a more positive forecast for IPOs across industries in 2017. Two-thirds (67 percent) of capital markets executives at leading investment banks predict an increase this year in IPOs on U.S. exchanges, BDO’s 2017 IPO Outlook study found, with 19 percent predicting a “substantial” uptick.

For the real estate industry, the IPO market may be marching ahead at a more measured clip, continuing to face many of the same hurdles that contributed to the recent downward trend in REIT IPOs, from nine in 2013 to four in 2016. BDO found executives’ predictions for real estate IPO activity fell in the middle of the pack among industries, with 37 percent expecting IPO activity to increase in the sector and 31 percent expecting activity to remain flat in 2017.

Publicly traded REITs posted positive returns of about 8 percent in 2016. Although the asset class underperformed the broader S&P Index for the year, NAREIT predicts a stronger 2017 for REITs and commercial real estate, driven by continued economic momentum and increased demand. Nonetheless, the sector will also grapple with big questions—most importantly, the possibility of a downturn as the current real estate cycle progresses. National Real Estate Investor notes REIT IPO activity this year could vary significantly across sectors and property types. Some REIT sectors are currently trading at a premium to their net asset values, so IPOs could be concentrated by sector this year. Of course, the decision to go public will ultimately be influenced by how the share price stacks up to the REIT’s net asset value.

Let’s take a look at REIT IPO activity so far this year and the factors that will impact how the rest of the year unfolds.

In January, Invitation Homes raised $1.54 billion in its offering, the largest U.S. IPO since October 2015 and the largest REIT IPO since November 2014. The company issued 77 million shares at $20. As of mid-March, the shares were trading at $21.40. Private equity group Blackstone purchased Invitation Homes in 2012 and spent approximately $10 billion to build Invitation’s portfolio of 48,000 homes, CNBC reported. Invitation’s homes are now 96 percent occupied and draw an average monthly rent of $1,623, according to Forbes.

Though this IPO comes after other recent bets on rental homes, including the merger of Starwood Capital and Colony Capital to form Colony Starwood Homes in January 2016, the window for IPO activity in the single-family home sector may be closing. Housing prices have rebounded significantly since the recession, but remain slightly below their pre-recession peak. Currently, there are 11 private single-family home rental businesses that own more than 1,000 homes each. Performance in the single-family REIT sector was strong in 2016 with 26 percent returns. But as the housing market steadies, portfolios are no longer available at “bargain prices,” so selling to a peer may generate better exit opportunity than an IPO for those businesses moving forward, Forbes predicts.

Other REIT IPO activity so far includes Connecticut-based Mortgage REIT Sachem Capital and New York City-based Clipper Realty. Sachem Capital opened for trading this year on Feb. 10 at $4.90 for its offering of 2.6 million shares. Shares are trading at $5.00 as of mid-March. Clipper Realty also debuted on Feb. 10, offering 5.6 million shares priced at $13.50 per share. The shares have hovered around that price, increasing less than 1 percent.

With economic uncertainty ahead as legislative and regulatory policy play out under the new administration, it is difficult to know how the capital markets and IPO activity may be impacted. The real estate industry’s recovery is entering its ninth year, and all eyes will be on key measures such as vacancy rates and rent growth. Focusing on these measures alone, however, overlooks the strong sector fundamentals set to support growth for commercial real estate this year, NAREIT asserts. Notably, demand for leased space is outpacing supply despite an uptick in construction in recent years.

Healthcare, industrial, net lease and manufactured homes portfolios are performing particularly well in the current market as most REITs in those sectors are trading at premiums to their net asset value, according to National Real Estate Investor. Those types of portfolios may be particularly ripe for IPO activity this year. Last year was a challenging IPO environment with many companies electing to forgo a public offering. But if the cadence of REIT IPOs in Q1 is any indication, that sentiment is changing fast.

This article originally appeared in BDO USA, LLP’s “Construction Monitor Newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

Building a Resilient Organization—A Toolkit for Nonprofit Boards to Manage Transformational Change

By Laurie De Armond, CPA

Many, if not most, nonprofit organizations will encounter board or leadership turbulence at some point in their lifecycles. Organizational transition, the evolution of mission or executive departures are inevitable. There are times when the board must make challenging decisions and protect the organization from financial and organizational risk, as well as potential reputation damage.

While the “transformational event” is often unplanned, the consequences don’t have to derail the organization’s programming, future plans or ability to successfully carry out its mission. There are a number of different methods and tools to address management hiccups and leadership transitions, as well as concrete steps boards and executives can take to minimize risk in the event of a transformational event.

To illustrate this, let’s examine a few scenarios:

  • Mission friction: A large national leadership and support organization for a variety of local chapters recently began pursuing a strategic partnership with another organization to expand its technical capabilities. Local chapters find the joint fundraising approach proposed by national leadership doesn’t support their priorities and programming at the ground level. There are also concerns in the chapters around increases in executive compensation, coupled with decreases in spending on certain service offerings national leadership believes no longer align with the organization’s broader mission. Some chapter advocates worry this tension could escalate if the strategic partnership moves forward.
  • Succession stress: A longtime CEO at a small research organization affiliated with a regional chain of hospitals has just been diagnosed with a severe medical condition requiring him to accelerate his retirement plans. The organization had begun preliminary preparations for its leader’s eventual retirement to plan and protect the organization from risk, but lacks a thorough succession plan and immediate action steps in the event of a departure as potentially sudden as this one.
  • Fragmented leadership: A foundation associated with a prominent, wealthy philanthropist that has national operations recently grappled internally with discord around its grantmaking practices and priorities. While the organization has yet to institute significant changes, leadership is at a crossroads and it’s likely the board will need to step in to determine future direction. The CEO is threatening to step down, which could likely spur media interest and generate significant negative publicity.

In order to build the right toolkit for forging a path through common transformative events like these, organizations need first to understand the various reasons the disruption occurs.

Mission Friction

Because many nonprofits operate on leaner budgets and resources than for-profit companies, keeping up with a rapidly evolving business landscape and the rise of technology as both a tool and a potential threat can be extraordinarily taxing. Some organizations are better able to navigate this than others. In some cases, like the one mentioned above, a joint venture, merger or acquisition with an organization that has technology infrastructure, or staff with certain expertise, can be the best path forward. However, expanding the organization’s capabilities can come at a high cost in the form of executive compensation and a new set of stakeholders to consider, which saddles the board with a challenging cost-benefit decision.

On the flip side, organizations reconsider the specifics of their mission or programming if they’re facing financial difficulties or are running a deficit. In cases like this, nonprofits may not have adjusted spending in certain areas, like employee benefits, despite slowing cash flow. The organization may also have expanded its programming and services into areas that no longer make sense given the marketplace, staffing or the needs of the community.

Some organizations encounter tension between founders and the board when a reconsideration of mission takes place—coined “founder’s syndrome.” Passionate, dedicated founders can be reticent to embrace certain changes in favor of the way things have always been done. The introduction of new board members with different perspectives can also serve as a conduit to bring issues and conflicts bubbling up to the surface.

During times of friction around a nonprofit’s mission, it’s critical that the board is educated on the issues at hand, as well as the consequences of each potential outcome and of inaction. Leadership also needs to have a dynamic vision of the organization’s future, and be willing to pivot if need be. From there, leadership may need to work with certain individuals at the board level to build consensus so that a risk mitigation plan, as well as a longer-term action plan, can be agreed upon and implemented.

Succession Stress

Succession planning is a moving target for nonprofits of all sizes and sectors. This is due in large part to the approximately 4 million baby boomers reaching retirement age each year, according to Pew Research Center statistics. While many are staying in the workforce longer than previous generations, the mass exit of experienced professionals, many of whom hold positions at the executive level or on boards, exposes some nonprofits to added personnel-related risk.

As a result, conversations around succession planning should shift from focusing on if a departure will happen, to when. Executive retirement can be planned, or, as we discussed above, it can happen quite suddenly. Regardless of the scenario, few things rock the boat like an executive departure. When considering your organization’s future growth and long-term plans, it’s important to proactively factor in succession planning. Depending on the size and scope of the organization, this may include a variety of tactics.

The succession plan may need to consider a potential gap between the current CEO and the successor and how workflow might need to be managed among other members of the leadership team, board and staff, as well as other practical details around the outgoing CEO’s exit and onboarding the new CEO. One stumbling block nonprofit organizations are particularly vulnerable to is a gap in relationship or partnership management with key stakeholders and donors.

The best way to mitigate the aftershock of a sudden departure is to ensure there is an up-to-date job description for the executive’s position. To develop this, the board should consider what skill sets are required for the executive to be successful in that role. Larger organizations might establish a transition team tasked with creating a transition plan, managing priorities, decision-making and communicating across the organization and to stakeholders.

Establishing a relationship with a search firm before the need arises can ensure the organization doesn’t have to vet search firms before beginning the candidate search, cutting down on overall hiring time. Executive hiring can take anywhere from six months to a year in some cases, so the board will need to develop an interim plan in case a successor isn’t immediately found. To bridge the gap during this period, the board should also consider whether there are other executives or board members who could hold the position or absorb the key duties of the role until the organization finds the right permanent replacement.

Fragmented Leadership

In the case of discord around financial priorities, the organization will need to ultimately choose where to allocate its resources—a tough decision that will likely land in the hands of the board. This is especially challenging if board members also have competing definitions of the organization’s mission and the purpose and goals of its grantmaking. The organization will also need to consider the impact of each possible outcome on its reputation.

There are several proactive steps nonprofits can take to unify leadership around the strategy driven by the board. In the example outlined above, the organization’s leadership could submit the pros and cons of each strategy to the board for consideration. The analysis should include the impact upon the organization’s finances, the impact upon its mission and potential reputational risks.

While there are many avenues for tackling a disruption at the executive level, organizations might consider bringing in a “transformational leader.” This individual would serve as a resource to educate key internal stakeholders, manage expectations and institute a plan of action for navigating and rebuilding consensus among leadership and the board. If an executive departs as a result of leadership fragmentation or evolution of mission and programming, this resource could also support the organization in development of a succession plan or communications plan.

The right brass-tacks qualifications each nonprofit organization will need in this leader are as wide and varied as the sector itself. In some cases, it might be beneficial for the individual to have a background in for-profit business. Alternatively, membership organizations, particularly in the medical or technology industries, might prioritize certain credentials that are required among members, to ensure the leader has credibility.

What tools do boards need to make the best decisions?

Above all, culture matters. A board that embraces change as an opportunity rather than an obstacle will enjoy smoother sailing during a rocky transformation of any kind. Arming the board to navigate uncertainty and inevitable change begins here. From there, in order to equip the board with the strongest toolkit possible for forging ahead through a transformational event, organizations should plan ahead by creating and maintaining certain key resources:

  • Board manual that members can reference during a transformational event. This should include standard documents, including the mission, strategic plan, bylaws and other important literature on the organization’s capabilities and services. When faced with difficult decisions, it’s important that board members have these resources close at hand to help them align their decision-making with the organization’s priorities.
  • Training to engage new and established board members. This training should cover key items included in the board manual, and set a tone for the relationship between the board and executive leadership. Additionally, organizations may consider annual workshops to build board members’ level of comfort with one another as well as their ability to collaborate to make decisions and reach consensus.
  • Information on relationships with key outside consultants and service providers, including staffing firms, financial managers and other resources. This will help ensure that all board members, not just the board chair, are equipped to deploy those resources should the need arise.
  • Board-approved succession plan, including caveats for various situations that could arise during an executive transition. This should include job descriptions for all leadership positions. During the development of this plan, the organization should identify and build a relationship with hiring and staffing resources, so that they can get familiar with the organization and its needs. This ensures they can be tapped quickly in the event of an unforeseen departure or transition. The succession plan might also include a list or information on the key relationships or partnerships managed by executives. To prevent gaps in relationship management during an executive transition, organizations can encourage shared ownership and an open flow of information so that key relationships don’t become siloed with one individual.
  • Step-by-step communication road map for navigating transformation and reputation management, including tools for presenting and discussing the event with various internal and external stakeholders and, if applicable, the media and public. The plan should include a list of key stakeholders who should be kept apprised of any leadership issues, as well as basic drafted language that can be filled in and adapted for use in a variety of situations.

While transformational events can arise from a wide breadth of causes and events, they all pose unique challenges to nonprofit organizations and require careful consideration of the risks in play and the right path forward. Boards that have developed contingency plans, and are able to focus on efficiently reaching consensus and pivoting when necessary, will be well-prepared to navigate the shifting tides they will inevitably face.

Article was originally published in Philanthropy Journal.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Spring 2017). Copyright © 2016 BDO USA, LLP. All rights reserved. www.bdo.com

Software Development Produces Significant Tax Benefits for Manufacturers

By Rick Schreiber, Chai Hoang and Chris Bard

Last year, over 6,000 manufacturers claimed more than an estimated $10 billion in research tax credits (RTCs), with each manufacturer’s average benefit exceeding $1 million. Generated in part by manufacturers’ efforts to develop new and improved products and processes, these benefits were also generated by their continued investment to develop or improve software to manage or automate production processes and business intelligence, among other things.

This year, thanks to new regulations that broaden the range of software development activities eligible for the credit, more manufacturers may be able to take even greater advantage of these dollar-for-dollar offsets against tax liability, enabling them to invest more in new technologies, expand their labor force and finance other business objectives.

RTC Explained

Often also called the “R&D credit,” the research tax credit is an activities-based credit. Federal and state RTCs are available, in general, to businesses that attempt to develop or improve the functionality or performance of a product, process, software or other component using engineering, physics, biology or the computer sciences to evaluate alternatives and eliminate uncertainty regarding the business’ capability or method to develop or improve the component or the component’s appropriate design (Qualified Research). RTCs equal to up to an average of 10 percent of qualified spending, which generally includes taxable wage, supply, contractor and cloud-computing expenses related to these attempts.

More than 6,000 manufacturers reported performing qualified activities last year, and a recent BDO/MPI Survey shows that this number could be double that. More than a majority (57 percent) of survey respondents said they weren’t planning to claim tax incentives like the RTC, even though they were planning to do development work to leverage the Internet of Things to capture and communicate more data more accurately and reliably. This type of work likely qualifies for the RTC, but many respondents said they weren’t going to claim it because they thought they lacked sufficient documentation or weren’t performing qualified activities.

Happily, these aren’t good reasons not to claim the RTC: several court cases have affirmed that oral testimony can be used to claim and support RTCs; and any manufacturer trying to make something better, faster, cheaper or greener is likely to be performing qualified activities, whether the activities succeed or not.

To that point, manufacturers in the following sub-sectors reported RTCs in 2013, the latest year for which IRS statistics are available:

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And although many of these credits related to attempts to design and develop new products and processes, many also related to efforts to develop new or improved software.

Software Development RTC Opportunity Expanded

New final Treasury Regulations issued in October will increase the RTCs manufacturers claim for software development.

Under current and former rules, software development activities fall into two categories, depending on whether the software being developed is intended primarily for the taxpayer’s internal use or not. What category the software falls into is important because “internal use software” (IUS) development activities must meet a higher standard to qualify than activities to develop non-IUS software.

The Final Regulations narrow the definition of IUS considerably. This means that considerably more software development activities are eligible for the credit, which means that more manufacturers may claim more RTCs going forward.

IUS is software developed for use in general and administrative (G&A) back-office functions that facilitate or support the conduct of the company’s trade or business. G&A functions are defined as financial management functions, human resource management functions and support services functions. Whether software is IUS depends upon whether the taxpayer, at the beginning of development, intended the software to be used primarily for G&A purposes. Software is not IUS if it is developed to enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system.

IUS development may also qualify. The regulations also provide that Qualified Research to develop IUS qualifies if it:

  1. Is intended to develop software that would be innovative, i.e., result in a reduction in cost, improvement in speed or other measurable improvement that is substantial and economically significant;
  2. Involves significant economic risk, as where the taxpayer commits substantial resources to the development and there is substantial uncertainty, because of technical risk, that such resources would be recovered within a reasonable period. The focus should be on the level of uncertainty and not the type of uncertainty; and
  3. Is intended to develop software that isn’t commercially available for use by the taxpayer without modifications that would satisfy the first two requirements.

Manufacturers and the RTC Tax Credit

The new regulations apply to a vast array of manufacturers’ activities, and businesses in this space should consider whether they’re missing out on opportunities to benefit from the RTC. Manufacturers have undertaken an effort to digitalize their operations, supply chains and markets. Companies are increasingly engaged in the development and improvement of business-intelligence software systems and enterprise-resource-management tools. The development, optimization and integration of the Internet of Things to enhance manufacturing and related processes also often qualify for RTCs.

Additionally, sales and operations planning require data from all aspects of a business, from production throughput and distribution and warehousing to financial metrics. The development and implementation of software to monitor and manage back-office functions could qualify for the RTC, e.g. activities to develop software related to:

  • Supply chain functionality;
  • Forecasting based on historical baselines, promotions and sales;
  • Pricing optimization, of both sales to consumers and procurement of supplies;
  • Inventory management;
  • Order management;
  • Revenue management;
  • Routing engineering/software development; and
  • Security against cyber-attacks.

Because the final regulations exclude from the definition of IUS software that is developed to enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system, manufacturers should review their software against the new definition and standards. For example, software developed to manage supply orders, sales or production data with third parties, or to enable customers or third parties to track delivery of goods, search inventory, or receive services over the internet, may qualify under the new regulations, without having to meet the higher standards for IUS.


Manufacturers of all sizes have been benefitting from the RTC since its inception in 1981. Now, with the new regulations on software development, many more should be able to benefit more than ever before, thus reducing their taxes, freeing up capital and gaining a competitive advantage. In addition, smaller manufacturers may be able to use the RTC against up to $250,000 of their payroll taxes or even their Alternative Minimum Tax.

This article originally appeared in BDO USA, LLP’s “Manufacturing Output” newsletter (Winter 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com