SF September 2022

LEADERSHIP STRATEGIES FOR ACCOUNTANTS AND FINANCIAL PROFESSIONALS

The Downsides of Stock Buybacks Revenue Recognition and Long-Term Contracts The SASB and Sustainability Standards SEPTEMBER 2022

TRANSFER PRICING STRATEGIES FOR THE NEW NORMAL

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Contents /9.22

Multinational enterprises need to reassess their approaches to transfer pricing in the face of changing global conditions.

26

FEATURE ARTICLES

26/ 34/ 42/ 50/ TRANSFER PRICING STRATEGIES FOR THE NEW NORMAL

THE DOWNSIDES OF STOCK BUYBACKS

external factors make now a good time for multinational corporations to reassess, reimagine, and reevaluate their transfer pricing strategies.

The persistent use of stock buybacks can result in a number of potential negative impacts and financial difficulties. Knowing the red flags and planning for the full impact can help manage the challenges.

BY TAE HYOUNG KIM, CMA, CPA, EA, AND NINA MICHELS-KIM, CMA, CSCA

BY ANDREW S. BARGERSTOCK, PH.D., CPA, AND NAVEED ABBASI

COVER STORY Changing

REVENUE RECOGNITION AND LONG-TERM CONTRACTS

Comparing the accounting techniques used for the old vs. new guidance highlights the differences in the new rules.

BY GREG GAYNOR, PH.D., CPA; JOHN PALMER, CMA; SUDHA KRISHNAN, PH.D.; AND SABRINA LANDA

THE SASB AND SUSTAINABILITY STANDARDS

Following the consolidation of the Value Reporting Foundation into the IFRS Foundation, the SASB standards will serve as a starting point for future standards and guidance on sustainability reporting.

BY AMANDA PAVAN, PH.D., AND JERRY G. KREUZE, PH.D., CPA September 2022 / STRATEGIC FINANCE / 3

Contents /9.22

42

34

PERSPECTIVES

8 THE ART OF COMPROMISE

BY GWEN VAN BERNE, CMA TOP LINE

10 CHANGING WITH THE TIMES

BY JEFFREY C. THOMSON, CMA, CSCA, CAE

SF BULLETIN

12 IMA: CMA QUESTION WRITERS NEEDED

12 N EWS: IFRS FOUNDATION

COMPLETES CONSOLIDATION WITH VRF

13 IMA: CARL MENCONI CASE WRITING COMPETITION

13 I MA: WELCOME, NEW CMAs! 14 B OOKS: EVEN ACCOUNTANTS BENEFIT FROM EXPERIMENTS

14 S URVEY: BURNOUT AMONG ACCOUNTANTS

ETHICS

TECHNOLOGY WORKBOOK

59 TECH FORUM

15 THE IMPORTANCE OF TRANSPARENCY

BY MICHAEL CASTELLUCCIO

BY DANIEL BUTCHER

61 TOOLS OF THE TRADE

BY MICHAEL CASTELLUCCIO

TAXES

17 TAXPAYER BILL OF RIGHTS

62 EXCEL

BY JAMES W. RINIER, CPA, EA, AND ANTHONY P. CURATOLA, PH.D.

BY BILL JELEN

64 TECH PRACTICES

BY FATEMA EL-WAKEEL, CMA

DIVERSITY

19 CONSIDERING CULTURAL ETIQUETTE

READ STRATEGIC FINANCE ONLINE:

IMA LIFE

BY PAUL MYERS, CMA, CSCA, CPA

66 A POSITIVE CHANGE

BY ANOOP AGRAWAL, CMA

LEADERSHIP

21 GOOD LEADERS EMBRACE CULTURAL DIVERSITY

BY STELLA PING LU, CMA, ACCA CFO TO CFO

23 STAYING THE STRATEGIC COURSE IN CRISES

SF PICK

Read every article of SF at SFmagazine.com and enjoy additional online content, including the SF Technotes and IMA Moments blogs—all in a digital format that’s easy to read, share, and print.

BY DANIEL BUTCHER

61

Authorization to photocopy Strategic Finance. Items for internal or personal use, or the internal or personal use of specific clients, is granted by IMA to libraries and other users registered with the ­Copyright Clearance ­Center (CCC) Transactional Reporting Service, provided that the base fee of $3.00 per copy, plus 30¢ per page, i​s paid directly to CCC, 222 Rosewood Drive, Danvers, MA 01923. (www.copyright.com) ISSN 1524-833X, $3.00 + 30¢.

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For permission to make 1-50 copies of articles, contact: Copyright Clearance Center www.copyright.com.

4 / STRATEGIC FINANCE / September 2022

VISIT STRATEGIC FINANCE ONLINE! 3:15

SFmagazine.com SF articles are in a digital format that’s easy to read, share, and print.

Access SF using your mobile device.

You can access content arranged by the topic of your choice.

SF Technotes appears as a twice-monthly blog on the website.

IMA Moments appears as a once-monthly blog on the website.

VOL. 104 NO. 3 September 2022

EDITOR-IN-CHIEF

CHRISTOPHER DOWSETT, CAE cdowsett@imanet.org

NATIONAL ADVERTISING MANAGER

ELIZABETH KENNEDY

MIKE WALKER The R.W. Walker Company, Inc.

SENIOR EDITOR

(925) 648-3101

SENIOR EDITOR

ekennedy@imanet.org

mike@rwwcompany.com

NANCY FASS

nfass@imanet.org TECHNOLOGY EDITOR

MICHAEL CASTELLUCCIO

mcastelluccio@imanet.org FINANCE EDITOR

DANIEL BUTCHER

COORDINATOR

ALICE SCHULMAN

aschulman@imanet.org

(201) 474-1547

daniel.butcher@imanet.org STAFF WRITER/EDITOR

LORI PARKS

lori.parks@imanet.org SENIOR DESIGNER

JAMIE BARKER

jamie.barker@imanet.org CIRCULATION

ALICE SCHULMAN

aschulman@imanet.org

FOR REPRINT INFORMATION, CONTACT:

Alice Schulman Phone: (201) 474-1547 Email: aschulman@imanet.org FOR PERMISSION TO MAKE 1-50 COPIES OF ARTICLES, CONTACT:

Copyright Clearance Center, www.copyright.com Strategic Finance® is indexed in the Accounting and Tax Index by ProQuest at ­www.il.proquest.com.

Except as otherwise noted, the copyright has been trans­ferred to IMA® for all items appearing in this magazine. For those items for which the copyright has not been ­transferred, ­permission to reproduce must be obtained directly from the author or from ​the person or organization given at the end of the article.

Views expressed herein are authors’ and do not represent IMA policy unless so stated. Publication of paid advertising and new product and service information does not constitute an endorsement by IMA of the advertiser or the product or s­ ervice.

EDITORIAL ADVISORY BOARD Bruce R. Neumann, Ph.D. Academic Editor Ann Dzuranin, Ph.D., CPA Associate Academic Editor William R. Koprowski, Ph.D., CMA, CFM, CFE, CIA Associate Academic Editor For more information on the role of the Editorial Advisory Board and a complete list of reviewers, visit sfmag.link/reviewers.

PUBLISHED SINCE 1919

6 / STRATEGIC FINANCE / September 2022

Strategic Finance® (ISSN 1524-833X/USPS 327-160) Vol. 104, No. 3, September 2022. Copyright © 2022 by IMA. P ­ ublished ­monthly by the ­ Institute of Management A ­ c­coun­tants, 10 Paragon Drive, Suite 1, Montvale, NJ 07645. Phone: (201) 573-9000. Email: sfmag@imanet.org. ­ MEMBER SUBSCRIPTION PRICE: $48 (included in dues, nondeductible); student

members, $25 (included in dues, nondeductible).

PERSPECTIVES

The Art of Compromise

BY GWEN VAN BERNE, CMA

M

ANAGEMENT ACCOUNTANTS TRADITIONALLY FOCUS THEIR WORK on decisions that involve the most revenue or the least amount of cost. With the increased focus now being placed on environmental, social, and governance (ESG) issues, we’re learning how to combine these priorities with a wider lens to analyze resource consequences in new ways and direct sustainable organizational outcomes.

Many times, dilemmas, paradoxes, trade-offs, and compromises can play an important role in this decision-making process. Although similar, each term has a slightly different meaning: A dilemma involves a tough choice because each decision option is firmly rooted in personal values. A paradox, on the other hand, seems contradictory, but a deeper investigation of the alternatives might reveal there’s some truth to all sides. Trade-offs are choices that necessitate the loss of something else, and compromises imply that neither side was chosen but a new and agreeable alternative was settled on instead.

I recently attended an IMA® chapter meeting where a sustainability officer from a well-known global fast-food chain shared examples regarding his company’s investment decisions. Some global studies suggest that chicken is the most sustainable meat option, but making the decision (as a company or as an individual) to switch to poultry becomes a painful one if it’s obvious that the better option is to simply eat less meat or if the data

conflicts with other studies. Having an incomplete picture of the issue takes away our ability to look at the real trade-offs, which in itself creates new dilemmas. How on earth, literally, can we decide which is the better option?

I think most of you will recognize that a lot of decisions end up as compromises. Finding common ground is mostly what we do in our work as management accountants. This requires that we keep an open mind, that we listen, and that we understand that resources are limited and valuable. Many times, challenges like this arise when we’re considering issues related to sustainability. Investment decisions are always trade-offs, where you must decide how to allocate money in the face of one or more sustainability dilemmas. In all cases, you must use tact to steer the data into the direction of an agreeable compromise.

We see these tough choices everywhere, which underpins why these conversations are so important. For a big change, the direction is always more relevant than the speed. Integrated thinking is an answer to a lot of our dilemmas, but there’s a clear need for objective facts and strong data. The finance department is perfectly positioned to give insight into an entity’s resource usage, which ultimately drives the development of new strategies and sustainable business practices.

It’s important to spot the real trade-offs inside and outside your organization and make sure that you generate the facts and forecasts needed to create meaningful organizational results. Compromise is vital, but know where you want to make a difference and let the data speak for itself. For more information, go to IMA’s Technology & Analytics Center (bit.ly/2n4LlJ5). SF

« For a big change,

THE DIRECTION IS ALWAYS MORE RELEVANT than

the speed.»

Gwen van Berne, CMA, is director of finance and risk at Oikocredit and Chair of the IMA Global Board of Directors. She’s also a member of IMA’s Amsterdam Chapter. You can reach Gwen at gwen.vanberne @imanet.org or follow her on LinkedIn at bit.ly/3LVeRGM.

8 / STRATEGIC FINANCE / September 2022

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Changing with the Times

H

BY JEFFREY C. THOMSON, CMA, CSCA, CAE

Jeffrey C. Thomson, CMA, CSCA, CAE, is IMA president and CEO. He also is a member of IMA’s BergenRocklandMeadowlands Chapter. You can reach Jeff at jthomson @imanet.org or follow him on Twitter: @IMA _JeffThomson.

EALTHY INDUSTRIES CHANGE: They innovate, adapt, and evolve to accommodate new realities, new awareness of issues, and new demands by consumers. For many of you, this may be the first time you’re reading this column on an electronic device, such as your desktop or laptop computer, your tablet, or your phone. That’s because we’ve made the decision to bring Strategic Finance into the Digital Age that we at IMA® talk about so often. Each month, you’ll be able to read SF through its digital edition—mimicking the layout and design of print—or online at SFmagazine.com. For a few select issues per year, starting with the January 2023 issue, you’ll also receive a print version.

There were a number of factors that went into this move to digital. First and foremost, this move is part of IMA’s overall strategy to invest in technology that will enable us to deliver a better, more robust member experience.

That includes development of our new IMA website, which will be unveiled this fall, featuring improvements to our e-commerce and payment capabilities (including the ability to support new international payment methods) and many other enhancements, as well as a new look and design for SFmagazine .com. Moving SF to a digital format is just one of the many initiatives designed to help us deliver our resources—insights to help accounting and finance professionals grow more successful in their work and lives—in more relevant, up-to-date ways.

The digital SF format will also allow us to offer you new content that we weren’t able to provide in a printed magazine. As we travel this digital

10 / STRATEGIC FINANCE / September 2022

journey, look for bonus features that can help you get even more out of our articles and columns: Links to relevant podcasts, videos, and additional online content will supplement and enhance your reading experience. Equally important, the updated SF digital experience—encompassing the monthly digital edition and the new website—will give readers more freedom and flexibility to consume SF content when they want, where they want, on whatever device they want.

Another benefit of this change is that it addresses environmental concerns that are endemic to publishing (and mailing) a print magazine. We at IMA care deeply about environmental, social, and governance (ESG) issues, so much so that we recently formed a global task force to help our profession contend with the challenges related to these concerns. As an organization, IMA is committed to standing by the principles of sound environmental stewardship. Put simply, the environmental impact of transitioning to a digital format will significantly reduce our carbon footprint and drastically cut our paper usage.

Strategic Finance is among the most valued IMA member benefits as well as an essential component of our mission to serve and support management accountants across the globe.

While we know moving to a digital format might be a tough transition for some, we hope that continuing to publish select print issues throughout the year will enable us to deliver a hybrid experience that gives our readers the best of both worlds.

And to ensure that we’re delivering the best content and experience possible for our members and the profession, IMA will continue to assess reader feedback. Please feel free to share your comments with me. SF

« SF is an essential component of our mission to SERVE AND SUPPORT MANAGEMENT ACCOUNTANTS.»

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Workday. The finance, HR, and planning system for a changing world.

© 2022 Workday, Inc. All rights reserved. WORKDAY and the Workday logos are trademarks of Workday, Inc., registered in the United States and elsewhere.

IMA/

CMA QUESTION WRITERS NEEDED

ICMA® (Institute of Certified Management Accountants) seeks subject matter experts to write multiple-choice questions and essays for the CMA® (Certified Management Accountant) exam.

Writers work on an independent contracted basis and are compensated for accepted questions or essays. Individuals who have earned their CMA certification are encouraged to apply.

For more information or to receive an application, please contact Jill Passantino at jpassantino@imanet.org. Information about the CMA program can be found at www.imanet.org/cma-certification.

80%

THE STATS

of those surveyed by memory researcher Catherine Loveday in 2021 felt their memories were worse than before the pandemic.

Source: The Guardian, bit.ly/3vZXgsv.

See “Is Digital Amnesia Real?” on p. 59 for more.

12 / STRATEGIC FINANCE / September 2022

NEWS/

IFRS FOUNDATION COMPLETES CONSOLIDATION WITH VRF

T

he International Financial Reporting Standards (IFRS) Foundation has completed the consolidation of the Value Reporting Foundation (VRF) into the IFRS Foundation.

The VRF consolidation follows the commitment made at the 2021 United Nations Climate Change Conference (COP26) to consolidate staff and resources of leading global sustainability disclosure initiatives to support the work of the International Sustainability Standards Board (ISSB) to develop a comprehensive global baseline of sustainability disclosures for the capital markets.

The consolidation will inform the work of the IFRS Foundation through the industry-based approach of the Sustainability Accounting Standards Board (SASB) standards and the Integrated Reporting Framework. The VRF’s SASB standards serve as a key starting point for the development of the IFRS Sustainability Disclosure Standards, while the Integrated Reporting Framework provides connectivity between financial statements and sustainability-related financial disclosures.

The ISSB, which now governs the SASB standards, is embedding the industry-based approach of the SASB standards into its standard-setting process, as well as addressing the international applicability of the SASB standards as a priority. The ISSB encourages companies and investors to continue to provide full support for, and use of, the SASB standards (see “The SASB and Sustainability Standards” on p. 50).

“I am delighted that the IFRS Foundation has finalized consolidation with the VRF,” said Erkki Liikanen, chair of the IFRS Foundation Trustees. “This consolidation follows the successful consolidation of the Climate Disclosure Standards Board in February. These consolidations help us to respond to the demand from stakeholders and deliver on the commitment we made at COP26—to harmonize the sustainability disclosure landscape and build on the work of existing reporting initiatives.” —Nancy Fass

®

WELCOME, NEW CMAs! IMA/

CARL MENCONI CASE WRITING COMPETITION Position yourself as a thought leader—submit an ethics case to the Carl Menconi Case Writing Competition by January 19, 2023.

I

MA® (Institute of Management Accountants) is now accepting entries for the annual Carl Menconi Ethics Case Writing Competition.

Don’t wait to start working on your submission because the deadline to submit an entry is January 19, 2023.

The winning case will be selected by IMA’s Committee on Ethics and featured in Strategic Finance. The case author or team of coauthors will be recognized at the IMA 2023 Accounting & Finance Conference in Minneapolis, Minn., June 11-14, 2023 (bit.ly/3oVNrYi).

Winners will also get one free conference registration and a $500 prize. Additionally, winners will have the opportunity to adapt their article into a slideshow and present it in an IMA Faculty Friday webcast (bit.ly/3byXDDa).

The competition works to develop and distribute teaching cases focused on business ethics with a specific application to management accounting and finance issues. It’s open to accounting and finance practitioners and academics, as well as students. Joint submissions from more than one contributor are encouraged.

Your submission must reference the IMA Statement of Ethical Professional Practice (bit.ly/3eYhCck). For more information about the competition and submission guidelines, go to bit.ly/3zROw8X. This annual program is named in memory of Carl Menconi, who held various leadership positions within IMA for many years, including serving as the chair of IMA’s Committee on Ethics. He also taught part-time at his alma mater, Northern Illinois University. —Daniel Butcher

612

IMA members became CMAs between July 1 and July 31, 2022.

The names of all the new CMAs can be found on the Strategic Finance website at bit.ly/3TxjE6s.

For more information on CMA certification, visit www.imanet.org /cma-certification.

September 2022 / STRATEGIC FINANCE / 13

Bulletin BOOKS/

EVEN ACCOUNTANTS BENEFIT FROM EXPERIMENTS

Learning the ins and outs of experimentation and applying takeaways to your role can give your career—and company—a boost.

S

tefan H. Thomke’s Experimentation Works: The Surprising Power of Business Experiments provides a practical, future-proof blueprint for driving business innovation via the scientific management method and creative problem solving. It’s filled with fascinating, real-world examples from recognizable household brands.

Harnessing various skills to execute successful business experiments will help finance professionals position themselves for future success in their career.

Thomke is a renowned authority on innovation management. His research is often cited by other experts in the field, and he’s been able to help global business leaders advance their organizations utilizing the scientifically backed approach of large-scale experimentation. Thomke outlines best practices, presenting examples of breakthroughs achieved and competitive advantages gained by organizations at the forefront of experimentation.

Most effective business models for sustainable growth typically involve innovation and ingenuity. Thomke argues that, given that even the most experienced and knowledgeable leaders are wrong more often than they’re willing to admit, a recipe for success is running rigorous experiments providing decision makers with unbiased, data-informed answers.

He writes, “The rationale behind experimentation is the pursuit of knowledge about cause and effect; all experiments yield information through understanding what does, and does not, work.” According to Thomke, as the fields of AI, machine learning, and neural networks advance, professionals skilled in the science and art of experimentation will benefit, and this practice will be required for the survival of many businesses.

Thomke does a brilliant job defining scientific jargon and concepts in an easy-to-follow, conversational manner. Mastering these terms alone makes this book a worthwhile read. He dissects copious examples of successful business experimentation undertaken by companies of varying sizes across a spectrum of industries. These revealing use cases provide an inside view of experimentation based on the scientific method, taking us from formulating a testable hypothesis to forming a causal link addressing a business question.

Businesses with a culture of experimentation are more likely to survive the test of time. If you want to master proven lessons of business experimentation, understand the value of small change, study the iterative nature of failures, build a testing infrastructure, define relevant metrics, and link strategy and data analytics, you need to read this book. —Alex Blyakhman, CMA, CSCA 14 / STRATEGIC FINANCE / September 2022

SURVEY/

BURNOUT AMONG ACCOUNTANTS

FloQast released the Controller’s Guidebook: Burnout in Accounting survey, revealing an alarming level of burnout among accountants.

Conducted in partnership with the University of Georgia’s Consumer Analytics program, the survey evaluated participants on a 100-point scale covering three major areas of burnout: emotional exhaustion, depersonalization, and low sense of personal accomplishment.

The survey found that:

90%

of accountants are experiencing some level of burnout, with 24% of those reporting high levels.

81%

of participants reported having their personal lives disrupted by the month-end close.

85%

of participants had to reopen the books in at least one month over the past year to fix errors.

Visit bit.ly/3JQ2ZGE to download the full report.

ETHICS

ETHICAL FINANCIAL REPORTING

THE IMPORTANCE OF TRANSPARENCY New reporting standards and evolving technologies present a whole host of ethical issues for professionals to grapple with.

W

BY DANIEL BUTCHER

HILE NEW ETHICAL ISSUES AND CHALLENGES

for management accountants have cropped up in the current environment of rapid technological evolution, other issues, such as those related to financial reporting, have been around longer. For instance, as the profession moves toward principles-based accounting standards as opposed to rules-based standards, many experienced accountants are grappling with the complexity of the former, as they’re more comfortable with rules because deciding what was right and wrong seemed black-and-white.

But whether you’re applying an ethical lens to reporting or to the use of new technologies such as data analytics and AI, it’s important to be transparent with stakeholders.

In the current environment, there’s pressure on finance executives at both public and private companies for completing accurate U.S. Securities & Exchange Commission (SEC) and other reporting and earnings projections, legal and regulatory requirements, and tax compliance, as well as keeping all the various stakeholders happy. Principles-based approaches in areas such as fair value add elements of judgment and subjectivity, which creates opportunity to be second-guessed. And there’s risk that superiors wanting to meet targets and make the results look good exert pressure on those responsible for reporting and disclosure to make questionable or flat-out unethical decisions.

“When preparing financial reports, there’s a lot of wiggle room that the accounting standards provide, and how much you take advantage of that is a very pertinent ethical decision that financial executives need to make,” says Richard Daisley, vice president of accounting and finance reporting content at KnowFully Learning Group’s Surgent Accounting and Financial Education.

A related reporting area that raises ethical issues is the reporting of environmental, social, and governance (ESG) factors, including corporate social responsibility. This can also impact supply-chain and procurement challenges.

There may be an ethical aspect to the questions: Where’s the company sourcing its materials September 2022 / STRATEGIC FINANCE / 15

ETHICS

from on the front end, and who’s it selling to on the back end?

“What were probably fairly straightforward decisions maybe in another era now, let’s face it, have political implications and ethical ramifications,” Daisley says. “There isn’t only the practical aspect of how to source what I need to keep my business open and the implications of keeping my workforce employed. Now it’s whose pockets is that money going into, and who’s going to be buying my products and what are they going to be using them for?”

In response to sustainability-disclosure guidance from the SEC, European Commission, and International Sustainability Standards Board, ESG reporting is taking on increasing prominence.

Where are those goods being produced? If they’re being extracted, what are the methods that are being used, and what are the standards for paying and treating the suppliers’ personnel? Those are examples of ethical considerations related to the supply chain.

“Whether it’s the compliance side or if it’s operational considerations, scrutinize the impact of what we do, what our suppliers do, and what our customers do more broadly,” Daisley says. “We’re about to get one common set of reporting standards on the ESG side very shortly, so a lot of the excuses for not doing ESG reporting are falling away, and it’ll be very interesting to see the different approaches that companies take, especially those in certain industries that leave 16 / STRATEGIC FINANCE / September 2022

a bigger environmental footprint, once we start quantifying that impact in more detail.”

Consistency in reporting and disclosure is important to ensure an ethical process. Finance team members need to think through the alternatives, agree on an approach, come up with a position that the CFO thinks is reasonable, and apply it consistently.

Sometimes it’s impossible to avoid uncertainty when faced with gray areas or tough decisions, but all professionals can do is try to home in on an estimate that’s in line with ethical standards and principles.

“If I’m trying to assess the reasonableness of someone’s position, the question I’m going to ask is, ‘You made this estimate or this judgment this year—how did that judgment pan out last year when you probably had to make a similar one, given similar circumstances?’”

Daisley says. “That adds credence to either the effectiveness of the decision-making process or in some instances the lack of effectiveness indicating that there should be a higher level of skepticism that we need here, so there’s a multitiered approach that people can take with regard to getting to that number that’s reasonable.”

ETHICS OF CHANGING TECHNOLOGY Another area where the concept of ethics comes into play is data privacy, protection, and use, which almost every company has to face. We have all this data, but who owns it, and how are we going to use

IMA

ETHICS HELPLINE For clarification of how the IMA Statement of Ethical Professional Practice ­applies to your ethical dilemma, contact the IMA Ethics Helpline.

In the U.S. or Canada, dial (800) 245-1383. In other countries, dial the AT&T USA Direct Access Number from www.business.att.com /collateral/access.html, then the above number.

The IMA Helpline is designed to provide clarification of ­provisions in the IMA Statement of Ethical Professional Practice, which contains suggestions on how to resolve ethical ­conflicts. The helpline cannot be considered a h ­ otline to ­report specific ­suspected ­ethical violations.

it? What’s the company’s responsibility when it comes to data management and respecting clients’ or members’ confidentiality?

For what uses do we need to get their consent?

Looking at AI and machine learning through an ethical lens, do employees and stakeholders really know what the algorithms are going to be spitting out? A lack of transparency tends to lead to a lack of trust. When the end user, customer, or investor can’t see how the blackbox algorithms got to the outputs, the business has to address it, and finance professionals can play an important role in breaking down how the organization is using new technologies.

“If you can’t explain how technology, particularly AI and machine learning, is impacting the decision-making process, then the level of trust that needs to exist between your entity and its stakeholders, and thus the whole value proposition, is going to break down,” Daisley says. “Companies that have the best approaches to maintain and enhance trust between themselves and their stakeholders are the ones that are going to be best positioned to prosper in this era—the ones that don’t foster that trust are going to pay a price, so it’s something that people need to think about more strategically and holistically as the changes in technology bring these ethical issues to light.” SF

Daniel Butcher is the finance editor at IMA and staff liaison to IMA’s Committee on Ethics. You can reach him at daniel.butcher@imanet.org.

TAXES

STATE TAX LAW

TAXPAYER BILL OF RIGHTS At the federal level, the Taxpayer Bill of Rights describes an individual’s rights before the government, while at the state level, it’s about limiting tax increases by the government.

T

BY JAMES W. RINIER, CPA, EA, AND ANTHONY P. CURATOLA, PH.D. HE TAXPAYER BILL OF RIGHTS (TBOR) IS A

broad term that refers to federal and state government initiatives that detail taxpayer rights in paying and disputing tax obligations. Under federal law, the TBOR spells out 10 rights for an individual when dealing with the Internal Revenue Service (IRS). At the state level, a TBOR typically seeks to limit tax increases by the state government. Thus, it’s important to be mindful that the term “TBOR” has a different meaning at the federal level (i.e., taxpayer rights) and the state level (i.e., restriction on legislators’ revenue-raising authority).

Colorado appears to be the only state that has passed a TBOR (also called TABOR) law. Five states have put a TBOR constitutional amendment up for approval by voters, but the amendment was rejected in all five cases. Proponents in other states have attempted to gain support for such legislation but have been unsuccessful in getting the amendment before the voters.

Why is there so much difficulty getting a TBOR amendment before voters, and why have voters in some states rejected it? The name itself is misleading.

The Center on Budget and Policy Priorities (CBPP) provides the following description of a TBOR: A Taxpayer Bill of Rights…is a constitutional measure that limits the annual growth in state (and sometimes local) revenues or spending to the sum of the annual inflation rate and the annual percentage change in the state’s population. (For example, if the general inflation rate is 2 percent and the state’s population grows by 1 percent, state revenue available for expenditures can increase by 3 percent.

The balance must be refunded to taxpayers.)

Overriding these limits requires voters’ approval or some other high bar, such as a supermajority vote of the legislature. (bit.ly/3cgMCq1) In general, this type of provision appears to severely limit the state’s spending. Opponents argue that it hinders a September 2022 / STRATEGIC FINANCE / 17

TAXES

state government’s ability to provide the necessary or expected public services. The CBPP reported that Colorado’s national rankings on several critical public services plummeted in the years after it adopted a TBOR in 1992 because of the TBOR’s forced deep spending cuts. Hence, the TBOR was viewed as a limit on government fundraising rather than as a list of taxpayers’ rights.

FEDERAL TAX LAW A TBOR at the federal level is as its name implies: a taxpayer’s list of rights for fair treatment when dealing with the IRS. The TBOR 2 (P.L. 104-168) included provisions that are intended to provide increased protection of taxpayers’ rights in complying with the Internal Revenue Code (IRC) and in dealing with the IRS. Its first provision was the creation of the Office of the Taxpayer Advocate.

The purpose of this office was to assist taxpayers in resolving problems with the IRS, identify areas in which taxpayers have problems dealing with the IRS, propose changes in administrative practices of the IRS that will mitigate those problems, and identify potential legislative changes that may mitigate those problems (bit.ly/3obktDB).

Nina E. Olson, former head of the Office of the Taxpayer Advocate, was a major advocate of the TBOR. In the 2007 annual report to Congress, Olson listed the TBOR as the number-one legislative recommendation.

But it was the IRS that announced in IR-2014-72 18 / STRATEGIC FINANCE / September 2022

the adoption of a TBOR, which appears in IRS Publication 1, as a cornerstone document to provide the nation’s taxpayers with a better understanding of their rights.

The rights that appear in IRS Publication 1 are multiple existing rights embedded and scattered throughout the tax code and organized into 10 broad categories. The objective was to make the rights visible and easier for taxpayers to track and understand. They are: 1. The right to be informed 2. The right to quality service 3. The right to pay no more than the correct amount of tax 4. The right to challenge the IRS’s position and be heard 5. The right to appeal an IRS decision in an independent forum 6. The right to finality 7. The right to privacy 8. The right to confidentiality 9. The right to retain representation 10. The right to a fair and just tax system Congress enacted the TBOR under IRC §7803(a) (3) in 2015, which is the same list of rights appearing in IRS Publication 1. IRC §7803 also added some teeth to the TBOR by stating the Commissioner of Internal Revenue is expected to execute his or her duties in accordance with the taxpayers’ rights. In addition, the commissioner must ensure that employees of the IRS are familiar with and act in accordance with listed taxpayer rights (i.e., the TBOR) as well as other provisions of the IRC.

HAVING THE TAXPAYER BILL OF RIGHTS AVAILABLE CAN MAKE SURE THAT TAXPAYERS KNOW THEIR RIGHTS FOR AN EXAMINATION, APPEAL, COLLECTION, AND REFUND AS THEY DEAL WITH THE IRS.

NATIONAL TAXPAYER ADVOCATE Congress also expanded on the functions of the Office of the Taxpayer Advocate. In particular, the national taxpayer advocate is required to carry out the same responsibilities as the Office of the Taxpayer Advocate.

With respect to the insight of the taxpayer advocate, IRC §7803(c)(2) (B) requires the taxpayer advocate to report to the Committee on Ways and Means of the U.S. House of Representatives and the U.S. Senate Committee on Finance on the objectives of the taxpayer advocate no later than June 30 of each calendar year.

These reports shall contain full and substantive analysis including statistical information. In addition, the reports are provided directly to the committees without any prior review or comments from the Commissioner of Internal Audit, the Secretary of the Treasury, any other officer or employee of the Department of the Treasury, or the Office of

Management and Budget.

In other words, Congress wants unfiltered information.

Being under audit by the IRS can be a daunting experience for any taxpayer. Having the TBOR available can make sure that taxpayers know their rights for an examination, appeal, collection, and refund as they deal with the IRS. IRS Publication 1 is now published in at least 20 different languages in addition to English ranging, in alphabetical order, from an Arabic version to a Vietnamese version. SF

James W. Rinier, CPA, EA, is an assistant clinical professor of accounting at Drexel University.

He can be reached at jwr29 @drexel.edu.

Anthony P. Curatola, Ph.D., is editor of the Taxes column for Strategic Finance, the Joseph F. Ford Professor of Accounting at Drexel University, and a member of IMA’s Greater Philadelphia Chapter. You can reach Tony at curatola@drexel.edu. © 2022 A.P. Curatola

DIVERSITY

CONSIDERING CULTURAL ETIQUETTE Learning and participating in different cultural practices helps professionals show respect to the members of different cultures with whom they interact. BY PAUL MYERS, CMA, CSCA, CPA

O

NE OF THE KEY OUTCOMES OF learning

and growing in diversity, equity, and inclusion is to better respect and appreciate the differences in perspective and approach. In a global community, one of the fundamental ways we can do that is to learn about different cultures and their etiquette practices. As accounting and finance professionals, many of us meet with individuals from different cultures in some capacity; for example, by attending events, taking business trips, and visiting or being visited by colleagues from another country, such as supply chain partners or coworkers from an international office.

Your organization might be working to serve a global marketplace, or you might be welcoming a new team member from another culture. You may have even made connections with other members from other cultures through activities in IMA® (Institute of Management Accountants) and its global community.

The diversity of thought and values from other cultures can bring many rewards, but it may also bring initial challenges when trying to ensure respect and inclusivity of practices and customs.

Derek Fuzzell, in the June 2020 issue of Strategic Finance, gave us an overview of understanding cultural archetypes and how this can help organizations more effectively conduct business across cultural lines (bit.ly/3oBidWg). Part of understanding these cultural differences involves learning and participating in cultural etiquette practices.

CULTURAL ENCOUNTERS Cultural etiquette is important when developing and maintaining relationships with individuals from other cultures.

Understanding the social manners of the cultures of the associates you’re working with will help you be prepared to most effectively participate in activities with them. The spectrum of customs varies from greetings to simple dining issues to more serious issues related to stereotypes or inequalities.

The first encounter may likely involve greeting one or more individuals. In today’s environment, you may have had the opportuSeptember 2022 / STRATEGIC FINANCE / 19

DIVERSITY

nity to first meet virtually, which may alleviate some of the anxiety you might have in this type of situation. Typical considerations involve whether there will be bowing vs. hand shaking and the related firmness, as well as which hand to use. You’ll also want to understand what’s appropriate for eye contact and the related implications. The overall order of whom you’re greeting to display the proper respect can also be of significance.

Knowing proper verbal greetings is important as well. For example, the practice of using first names, surnames, titles, degrees, and so forth varies from country to country, so learn what’s appropriate. Knowing some common or key phrases in the local language also could be very useful in making a connection.

In conjunction with the gestures involved in the greeting process, there are other notes about how we use our hands in areas of indication and conversation.

The use of hand gestures and how they’re interpreted may vary by culture. Some examples of gestures that have different meanings in different areas of the world include: the V(ictory) sign, pointing fingers, and crossing fingers. The direction of the hand, or the use of right hand vs. left hand, can also impact the meaning of a gesture. The best practice would be to avoid or minimize the use of hand gestures until you have confirmed their meaning with someone in that culture.

FOOD AND DINING DIFFERENCES Another common area where accounting and 20 / STRATEGIC FINANCE / September 2022

finance professionals might encounter cultural differences is when dining. There are many areas included under this topic, so it can be helpful to do some research prior to the lunch or dinner meeting.

One main area of consideration is the types of food to order. The foods that you eat in your average day might not be acceptable as part of the diet in other cultures, so educate yourself beforehand when possible.

For example, ordering chicken is often a more common safe choice than beef or pork due to cultural standards that may stem from religious or other social practices. You may also want to note the use of additional spices or condiments, as some cultures consider adding these an insult that the food wasn’t prepared properly. Learning how many courses are expected with the meal can be helpful as well so that you can pace yourself accordingly.

If you’re traveling abroad and attending a business dinner at a restaurant, you’ll want to recognize what the practice is for tipping, because some cultures are offended by it while others expect it. It’s also good to understand the implications of clearing your plate, as some cultures show respect by refilling plates when emptied. When in doubt, follow the lead of the other guests or the host as much as possible. Be open as much as your dietary practices allow to show courtesy to your hosts. Showing your gratitude for the efforts of hospitality will be much appreciated by those providing it and can help strengthen relationships.

MAKING AN INVESTMENT TO LEARN ABOUT THOSE YOU’LL BE MEETING AND ENGAG­ING WITH WILL REFLECT YOUR RESPECT FOR THE RELA­TIONSHIP.

LEARNING TO COMPROMISE Cultural etiquette may require a level of compromise at times. Sometimes, the compromise will be minimal, easy to accept, and possibly even enjoyable. Other times, the differences between cultural norms can be rather significant. For example, the roles between genders may be viewed differently, which can lead to various emotions. Other cultural stereotypes that might cause you to struggle may be based on race, sexual orientation, or age. When possible, understand how your company manages or addresses those differences in these multicultural relationships. It’s important to evaluate your values and what you’re comfortable with changing, and where compromise may not be possible.

The best plan in being prepared to deal with cultural etiquette is to be informed and do your research. Assuming that your interaction will be related to a work function, one of your best resources can be to review information with coworkers who have already participated in similar events or trips. They will likely have the most relevant information to guide your specific situation.

Another option would be to reach out to trusted peers who have engaged with partners in the same or a similar culture.

Online research can be useful as well, but do your best to verify information on more than one trustworthy website for accuracy and authenticity. Depending on the level of your relationship, you can even reach out to those you’ll be meeting to share your sincere intention to respect and learn their culture’s practices.

Learning about and participating in cultural practices that are new to you display your openness to new ideas and connections. Making an investment to learn about those you’ll be meeting and engaging with will reflect your respect for the relationship. Through these efforts, you’ll help put into practice the principle of inclusivity and respect to your coworkers, candidates, business partners, and beyond. SF

Paul Myers, CMA, CSCA, CPA, is a client services associate at Vantage Point Financial Services, LLC; former chair of IMA’s Diversity, Equity, and Inclusion Committee; and a member of IMA’s Dayton Chapter. He can be reached at myersp70@gmail.com.

LEADERSHIP

GOOD LEADERS EMBRACE CULTURAL DIVERSITY Effective leaders foster cultural diversity and respectfully consider different perspectives to cultivate innovation.

R

BY STELLA PING LU, CMA, ACCA

EADING PEOPLE’S BODY LANGUAGE IS AN IMPORTANT FACET of

effective communication. If a person is nodding his head, does it mean no? It depends on whom you’re talking to. Further, if you’re speaking with someone of Indian descent, the answer depends on which province that person comes from. In this case, you may have to ask and get verbal confirmation.

When management accounting and finance leaders communicate with people, whether they’re clients, direct reports, or peers, you need to factor in the context, including their cultural background, to know the meaning of their body language.

This insight comes from my experience living and working in the United Arab Emirates (UAE), a country with residents of more than 200 nationalities. In the UAE, 89% of the population are expats, of which 51% are from India, Pakistan, Bangladesh, and Sri Lanka (IPBS).

Only 2% are from my home country, China. In the financial department I’m working in, around 80% are from IPBS. Although I’ve worked with people from different countries and relocated a few times in Asia during the past 20 years, there was still a period of culture shock for me after moving to the UAE in early 2021 in terms of adjusting to residents’ religions, ways of communication, dress code in public, and so forth.

I worked with different teams in my employer’s corporate group and led a few process-improvement projects, including the accounting and finance modules in enterprise resource planning (ERP) implementation.

How can you successfully play a leadership role in a multinational workplace environment? The following are some tips from my firsthand experience working abroad.

BE RESPECTFUL In the Middle East, for most Muslims, five prayer time slots per day are mandatory, even during working hours. Prayer rooms are in shopping malls, airports, and offices—basically everywhere. People often request a prayer break September 2022 / STRATEGIC FINANCE / 21

LEADERSHIP

during meetings, especially ones that end up being longer than planned or that overlap with a designated prayer time. It’s natural for UAE locals to take prayer breaks, and they’re considered essential to have a refreshed mind and come back to work full of energy. After I was notified of this need, I tried to avoid prayer times when scheduling meetings with some buffer time built in.

Respect, coupled with open-mindedness, is so important. I usually associate different behaviors that are normal in other cultures with my own lifestyle, which consists of personal choices based on a different cultural background. People could feel this respect clearly and in turn gave me their respect by accepting my own culture.

BE A LEADER, NOT A BOSS A leader doesn’t necessarily have to be a stereotypical boss to get the best joint team achievement. A leader’s role is to make the team work well together toward achieving common objectives while making good use of team members’ talents and benefiting from their diversity.

In a multinational corporate environment, several projects are being executed simultaneously at any given time. I had the opportunity to lead projects, for example, an ERP implementation involved in almost all business functions across all the company’s subsidiaries.

I’m now working in the corporate finance function and leading the group reporting module in the ERP implementation, which 22 / STRATEGIC FINANCE / September 2022

is the financial consolidation model for the company.

In this model, the balance between the need of the group, clusters, and subsidiaries are quite important due to the different levels of consolidation required and the reporting needed from the various entities. The key users for the group reporting module are the finance teams.

After discussion with a management consultant, we defined the overall project-execution approach: Corporate executives lead the structure design of the group reporting process, and the subsidiaries get involved in detailed content design to balance the hierarchy requirement from the three levels: corporate, clusters, and subsidiaries.

Regular communication channels were planned during the project execution timeline to make sure the key points could be captured and evaluated properly. This project is running well and on schedule.

CULTURAL VALUE-ADD VS. VALUE ADAPTOR When new people from a different culture join the team, it’s better to embrace diversity as a cultural value-add instead of expecting them to adapt themselves to fit the existing culture without accommodation. Newcomers usually try to adapt to the new workplace environment. At the same time, we may make use of this diversity to consider different perspectives and become a more innovative team.

Rocío Lorenzo, a partner and managing

SF

ADVICE IMA LEADERSHIP ACADEMY The IMA® Leadership Academy supports the development and enhancement of our members’ leadership education and skills to aid in career advancement.

From presentation of or participation in leadership courses offered in person or virtually to our community of experienced leaders through our mentoring program to IMA’s leadership recognition program where members can measure their development and earn digital badges, the IMA Leadership Academy can help you meet your leadership goals. For more information, please visit the Leadership Academy website at www.imanet.org /career-resources/leade­rship -academy.

director at Boston Consulting Group, conducted a research project with her team for 1,600 companies in eight countries around the world in 2017. They asked how innovative and diverse the companies are.

To measure the first one, Lorenzo used innovation revenue, the share of revenues made from new products and services in the last three years, meaning creative ideas that have translated into products and services that have made the company more successful.

To measure diversity, six different factors, including country of origin, age, and gender, were used. The result of the data analysis was clear: More diverse companies are more innovative. A diverse and inclusive environment allows people to speak up and be their authentic selves, which boosts the potential of each employee and makes the company more creative and profitable.

My team contains people from more than 10 countries and with different education and work backgrounds. We regard everyone as a contributor to the team and achieved an excellent performance evaluation for the past year. Embracing diversity adds value in my personal life and career journey as I grow into my leadership roles managing the workflow of our team in a multinational environment. SF

Stella Ping Lu, CMA, ACCA, is group financial controller at EDGE Group and a member of IMA’s Hong Kong Chapter. You can reach her at stellaluping @gmail.com.

CFO TO CFO

STAYING THE STRATEGIC COURSE IN CRISES The CFOs of Inspire Brands and Baker Hughes discuss how to maintain a strong balance sheet and innovate in challenging times. BY DANIEL BUTCHER

W

HEN DEALING WITH A CRISIS such

as a pandemic or geopolitical conflict causing supply-chain disruption and other challenges, it’s easy for companies to focus on putting out fires and shoring up the balance sheet to get through the quarter. The best finance leaders, however, aim to navigate choppy waters while maintaining a big-picture perspective and continuing to invest in the company to build for the future. In a conversation with Strategic Finance, Brian Worrell, CFO of energy technology company Baker Hughes, and David Pipes, recently retired CFO of Inspire Brands, whose portfolio includes Arby’s, BaskinRobbins, Buffalo Wild Wings, Dunkin’, Jimmy John’s, Rusty Taco, and Sonic Drive-In restaurants, talked about balancing short-term demands and tactics with long-term objectives and strategic plans.

SF: What may CFOs overlook or give short shrift to during stressful times?

Worrell: It’s easy in times like this to focus on the to-do list or the task at hand to demonstrate some wins. And during these periods of uncertainty and heavy activity, teams look for concrete examples on progress. Lots of moments during these times, I try to encourage the team to stay externally focused to ensure that we aren’t missing anything in the market. Subtle shifts can make a big difference. It’s important to ask the right questions and continue to make sure you’re bringing in relevant examples from other companies of what’s going on in the market. And if you’re making some bets that aren’t on other people’s task list, make sure you communicate those so everyone understands that you’re investing in the company’s long-term growth.

One thing that has to be in the forefront of each leadership team is making sure you spend time and motivate and inspire teams, even during critical periods, whether they’re going through an M&A [mergers and acquisitions] integration, whether there’s a big project that’s due or supply-chain disruption like we’ve seen in the last year, and sometimes overcommunicating can be important. But making those long-term objectives turn into bite-size wins can be incredibly helpful.

Pipes: The most important thing as it relates to that is keeping in mind that long-term goals can’t be put off until the September 2022 / STRATEGIC FINANCE / 23

CFO TO CFO

long term. In other words, if you lose sight of that, then your three-year goal is effectively a rolling three-year goal. If you aren’t working on it along the way, it’s always three years out.

So, it’s important to keep in mind that you have to continue to nourish these goals, and there are short-term objectives that need to be achieved toward the completion of the long-term goal.

For example, if I’m talking about facility-remodel goals, unit-expansion goals, or technology goals, those are all things that you can’t just decide, “We want this done in three years, and then we’ll start on it in three years.” And then the other aspect of that is whatever the stressful time may be, remember that your business landscape in the broader world may be different at the end of it. And so you have to think ahead as to how you want to operate or what you think things will be like post the urgent situation and how you’re going to manage your business during those times.

to creep in. The CFO at times like these has to be in the details and making sure teams are focused on these areas.

Generally, the teams follow the CFO’s lead, so it’s critical to share insights on the balance sheet with the operating team. A few times in my career, I’ve seen companies leave red flags just to the finance teams to spot and fix, and that’s never a good recipe. The CFO must communicate and be very transparent about issues and get out ahead of things early. If you start to see those warning signs, start to work on them immediately because it’s much easier solving a small problem sooner than a big problem later.

Pipes: As you think about the financial red flags, there are the normal financial red flags and then those associated with something as big as a pandemic. But monitoring the cash flows, and, certainly, if you go from positive cash flows to negative, that’s a red flag.

When you aren’t meeting your plan or your forecast, posting negative yearover-year sales, things slowed, collections of receivables, all those things are

come down even further because you can’t provide service to the customers that come in. We also pulled down availability under our lines of credit to shore up the balance sheet, and I even borrowed some additional funds. Again, tapping into the financial markets, we increased the availability under the lines of credit to be ready in case we needed to do more.

And then one of the bigger things that we did, which was not an immediate benefit, but it was a huge benefit, was to understand the changing tax provisions associated with the pandemic and the CARES [Coronavirus Aid, Relief, and Economic Security] Act. And we were able to save many millions of dollars of cash taxes by taking advantage of the changes that were there for everyone to utilize. We had a team that was working on all aspects of it. Constant communication is critical. We were meeting as an executive team really every day for a while as we worked to make sure that we were keeping things moving as best we could.

“The CFO must communicate and be very transparent about issues and get out ahead of things early. If you start to see those warning signs, start to work on them immediately because it’s much easier solving a small problem sooner than a big problem later. ” —Brian Worrell

SF: What are financial red flags that the balance sheet needs to be shored up? And what options should the CFO consider?

Worrell: I’m constantly looking for any trends in cash, any cash lanes, working capital metrics going in the wrong direction and maybe not at the right time. There are times where you expect working capital to build, so if you can see some unusual things happening there, I always look out for significant changes in the other assets and liabilities category because that’s where sometimes an early warning can start 24 / STRATEGIC FINANCE / September 2022

red flags. Some are more critical than others. So once you see that, and one of the first things we did, we pulled back on all discretionary spending. We have a lot of capital spending that we do for remodels and new restaurants, even projects that don’t have to be done in a situation like that, so we made a decent pullback there. At the same time, though, we made sure that as we were reducing spending, we were careful not to do it in a manner that’s going to have the effect of exacerbating the problem.

If you pull too much labor out of the restaurant, then your revenues

SF: How can CFOs use data analytics and research to inform financial planning and analysis (FP&A) and long-term strategic planning?

Pipes: Data analytics is critical to understanding the business at any point in time and very helpful in terms of being able to develop your pandemic response, stay ahead of trends, understand what your shortterm forecast should be, and develop the longer-term forecasts. For example, early in the pandemic, it was quickly apparent that even when we were doing okay in some of the brands

“Data analytics is critical to understanding the business at any point in time and very helpful in terms of being able to develop your pandemic response, stay ahead of trends, understand what your short-term forecast should be, and develop the longer-term forecasts.”

—David Pipes

in terms of revenues, the transactions were still way down, and the check was way up. We also saw a huge growth in digital and mobile ordering. And so people were approaching our restaurants differently than they did before, and understanding those changes in purchase behavior enabled us to make changes in marketing and product offerings, like more dinner-type offerings for big groups, how we deployed labor, how much of a discount to offer, and our whole approach to discounting. That information we gathered from analyzing the business was important. So on the one end, it gave us more data to work with in terms of analytics, but it also enabled us to know where we can invest more in that area to see it continue for the longer term and where we can pull back. We didn’t do as much television advertising, but we did focus on promoting carryout, getting delivery, and using mobile ordering.

Worrell: Integrating data and analytics and overall research into FP&A and long-term planning is certainly an evolutionary process with the amount of data that’s being generated within and outside the business.

We’ve done a good job as finance professionals, specifically at Baker Hughes, integrating data analytics into performance metrics, looking at anomalies, and driving compliance and controllership. We make pivots around our supply chain—for example, are we paying the same price for parts all over the world, or is one region or part of the company paying a higher price? We’re also getting much better integrating broader industry metrics and research into

longer-term financial planning by looking at trends over time and trying to study other cycles.

In the energy industry, specifically in oil and gas, we’ve had a ton of cycles. We use insights from previous cycles to try to model what we think is happening today, and what I like is the data-rich environment we live in today. You can actually get down and model a lot more at a customer level and a type of [product] level; we’re using all that to inform some of our investment decisions as well as the strategic direction of the company. Another way that we use research and data analytics at an HQ level is to make sure we’re informing our dialogue with the operating teams when we’re talking with them about their performance and planning for the next year. And we do a temperature check on our relative performance vs. others in the market, so it helps everyone be a little more informed and have a good fact-based discussion when we’re talking about medium- to long-term plans.

SF: During crises or challenging periods, how can CFOs help colleagues weather the storm, meet short-term obligations, and focus on longer-term strategy?

Worrell: The most important thing that we do during this time is to help the teams break things down into bite-size objectives. People, including me, like to see that they’re making progress and are really making a difference, and that was very important during the pandemic and what we saw on the energy markets last year. I also think it’s important to acknowledge those wins and give teams some

things to think about doing better, so we took that balanced scorecard approach. And we in finance have to consider internal perspectives from our company’s leaders and balance that with external perspective from our investors and capital markets, and asking, “How’s the competition doing?

What are we hearing from customers?” The answers to those questions can motivate a team and help keep the long-term goals in focus while still achieving short-term wins.

Pipes: The key overall is consistent communication. At the executive team level, we talk a lot as a group about what’s going on in the business and how we’re approaching it. The next layer down is working cross-functionally as well, working with the teams and maintaining that relentless focus on what’s working and what isn’t and how we adapt to the changing circumstances. As a franchisor of restaurants, we communicated as well to our franchisees to help them understand some of the adjustments that we were making on our own company operations, in our marketing, etc., but also helping to ensure that they were aware of the aid that was available to them from other resources such as the PPP [Paycheck Protection Program] money. And so, all that was helpful in ensuring that those businesses stayed healthy, which certainly has an impact over the long term on our business as well. SF

Daniel Butcher is the finance editor at IMA and staff liaison to IMA’s Committee on Ethics. You can reach him at daniel.butcher @imanet.org.

September 2022 / STRATEGIC FINANCE / 25

TRANSFER PRICING STRATEGIES

FOR THE NEW NORMAL Multinational enterprises need to reassess their approaches to transfer pricing in the face of changing global conditions.

BY TAE HYOUNG KIM, CMA, CPA, EA, AND NINA MICHELS-KIM, CMA, CSCA

September 2022 / STRATEGIC FINANCE / 27

M

ultinational enterprises (MNEs) account for nearly 80% of world trade. Many countries depend on tax revenues from MNEs, which has led to tax authorities around the world frequently and aggressively targeting the appropriateness of transfer prices. As a result, transfer pricing, one of the main technical topics within global supply chain management, is now even higher on the agenda for CFO teams of MNEs. Since 1979, the Organisation for Economic Co-operation and Development (OECD) has set international standards in transfer pricing. In January 2022, the OECD published the updated Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (Guidelines). In response, CFO teams of MNEs need to refine company-wide transfer pricing. But doing so won’t be as straightforward as it has been in the

past. Significant changes in the world and the emergence of a new normal have made it unusually challenging for MNEs to simply follow the Guidelines on transfer prices without considering the impact on overall business operations.

Transfer Pricing

Similar to an “intracompany” transaction price (between divisions within a single entity) in management accounting, the transfer price in international tax includes an “intercompany” transaction price between entities of one MNE group. More precisely, the OECD Guidelines define transfer prices as the prices at which an enterprise transfers physical goods and intangible property or provides services to associated enterprises.

In setting the price for the transfer, the MNE must apply the arm’s length principle, where the transfer price shall be determined based on the commercial or financial conditions that are like those between independent parties in

FIGURE 1: EXTERNAL FACTORS IMPACTING TRANSFER PRICING

COVID-19 and its aftermath

ESG

Nationalism

Transfer Pricing in the Era of the New Normal

International taxation on digital economy

28 / STRATEGIC FINANCE / September 2022

Digitalization

Finding an appropriate price isn’t always easy because every MNE has different comparability factors.

comparable circumstances. In other words, the price must approximate one that would reasonably be used in a transaction between two unrelated organizations. According to the OECD Guidelines, these comparability factors include the (1) contractual terms; (2) functions performed, risks assumed, and assets used; (3) characteristics of property transferred or services provided; (4) economic circumstances of the market; and (5) business strategies pursued.

Finding an appropriate price isn’t always easy because every MNE has different comparability factors. For example, in some cases, there’s no open or clear market for the service or product on which to base the price. Many countries have long used the OECD Guidelines on transfer pricing as the basis for the legislation of their own domestic laws for taxing MNEs. In addition, MNEs now also use the explanations provided in the Guidelines as a reference in the application of global business operation beyond tax-related matters.

External Factors Impacting Transfer Prices

Of the many recent developments, we believe the following five external factors have direct and critical impacts on transfer prices. These factors are closely correlated in many ways and have led to the era of a “new normal” (see Figure 1).

COVID-19 and its aftermath. The ongoing impact of the global COVID-19 pandemic has made it impossible to operate traditional transfer pricing structures. Of course, business impacts of the pandemic vary depending on the industry sector, product type, or geographic location. Yet most companies, especially those with a significant global presence, faced workplace transformation, supply chain disruptions, decline of financial liquidity, and restrictions to cross-border movements. Together, these impacts have contributed to a global economic downturn.

The OECD published Guidance on the transfer pricing implications of the COVID-19 pandemic in December 2020 to provide clarification and support for corporate taxpayers and tax administrations in evaluating and applying transfer pricing rules for fiscal periods impacted by the COVID-19 pandemic. With negative impacts on profitability, MNEs must review current transfer pricing policies to reallocate group-level profits based on the economic substance of each related party’s functions, risks, and assets.

Rising nationalism. From a political point of view, nationalism has recently become even stronger, with intense conflicts as populist leaders and their administrations have focused on the best interests of their own countries regardless of the impact on other countries. For example, political friction between the United States and China has arguably added complications for U.S. and China-based MNEs in many ways, as well as the suppliers and customers of these enterprises.

In more extreme cases, countries pursue tax incentives or deregulation designed to promote the reshoring of foreign subsidiaries to generate domestic employment and retain domestic tax revenues. Severe conflicts between countries may require a change in the overall supply chain and transaction structure. MNEs engaged in trade in Russia and in the European Union are facing difficulties with interrupted supply chains and energy procurement caused by the war between Russia and Ukraine and the indirect effects of economic sanctions.

With rising nationalism around the globe, MNEs need to monitor the change of local government politics continuously to readjust their transfer pricing policies in a timely manner and reduce business risks from political actions and events.

Digitalization. Digitalization and the Fourth Industrial Revolution have greatly changed global economies and work environments. Concepts such as AI, robotic process automation, the Internet of Things, blockchain, metaverses, cryptocurrencies, and nonfungible tokens have the potential to make our lives more convenient while also generating efficiencies in enterprise trade.

As Wilfred W. Wu, Henghsiu Lin, and James Jurinski wrote in “Adding Blockchain to Business Curricula” (Strategic Finance, August 2021, bit.ly/3ORyMrU), blockchain technologies will give us access to real-time data that will improve verification of transfer pricing by tax authorities while decreasing reliance on excessive paperwork and documentation. At the same, this digitalized economy will also displace some jobs while creating new ones, thereby altering MNEs’ business structures. As such, MNEs will need September 2022 / STRATEGIC FINANCE / 29

FIGURE 2: 15 ACTIONS OF THE BEPS PROJECT

Coherence Hybrid Mismatch Arrangements (Action 2) Controlled Foreign Corporation Rules (Action 3) Interest Deductions (Action 4) Preventing Harmful Tax Practices (Action 5)

Substance

Transparency

Preventing Tax Treaty Abuse (Action 6)

Avoidance of Permanent Establishment Status (Action 7)

Transfer Pricing Outcomes with Value Creation (Actions 8-10)

Digital Economy (Action 1)

Methodologies and Data Analysis (Action 11) Mandatory Disclosure Rules (Action 12) Transfer Pricing Documentation (Action 13) Dispute Resolution (Action 14)

Multilateral Instrument (Action 15)

Source: OECD

to adopt their transfer pricing policies based on changes driven by digitalization.

International taxation of the digital economy. After the global financial crisis in 2008, many developed countries experienced reduced tax revenues from MNEs’ tax plans. The OECD concluded that $100 billion to $240 billion (approximately 4% to 10% of global corporate tax revenues) are being lost annually due to tax avoidance by MNEs. As a result, the OECD and the G20 initiated anti-base erosion and profit shifting (BEPS) frameworks in 2012, with 141 countries adopting the BEPS project guidance.

The BEPS project is comprised of 15 actions that basically cover recent and controversial issues in the international taxation system, such as tax treaty abuse, permanent establishment, hybrid mismatch arrangements, harmful tax practices, and so forth (see Figure 2). Of the 15 actions, four are directly related to transfer pricing: Actions 8 through 10 focus on transfer pricing specifically, addressing intangibles, risks and capital, and high-risk transactions, respectively; and action 13 addresses transfer pricing documentation and country-by-country reporting. This underlines the importance of transfer pricing to international taxation systems.

As countries revise their domestic tax laws to reflect the BEPS project’s guidance, tax authorities from various jurisdictions may conduct more aggressive tax audits, which 30 / STRATEGIC FINANCE / September 2022

would likely lead to more disputes such as tax appeals and litigation. To mitigate these potential risks in advance, MNEs must apply consistent global transfer pricing policies, prepare substantial transfer pricing documentation, and manage justifiable allocation of global profits based on such factual relations.

Environmental, social, and corporate governance.

The global movement toward better management of environmental, social, and corporate governance (ESG) issues has pressured corporations, including most MNEs, to improve their transparency. To address the governance aspect, for example, some Korean MNEs state on their websites that they have established and operated effective tax policies (including transfer pricing) that comply with the relevant regulations, which prove their sustainability in terms of governance. As shareholders’ and potential investors’ expectations on ESG management continue to increase, MNEs’ establishment and implementation of their global tax policies have become more important.

Effective Transfer Pricing Strategies

Transfer pricing isn’t an exact science. MNEs need to determine transfer pricing based on the unique characteristics

of their business strategies, functional profiles, economic conditions, legal terms, etc. Consequently, there’s no single, perfect solution that all MNEs should adopt to cope with recent challenges.

Yet we propose that there are several general, yet very critical, points for transfer pricing implementation that MNEs can bear in mind. Our suggestions all start with the prefix “re-,” meaning again or backward. In this era of the “new normal,” now is the time for MNEs to take a step back and reconsider or reimagine their transfer pricing strategies to fully respond to the rapidly changing global environment.

Restructure businesses. As previously mentioned, MNEs must revisit their outstanding transfer pricing policies to determine whether they’re flexible to accommodate external or unexpected factors such as COVID-19. At the same time, they must review whether current transfer pricing structures are aligned to the groups’ future business prospects. When any vulnerable areas exist, MNEs may consider business restructurings.

For the evaluation of transfer prices, each MNE entity’s expected return (profit) can be determined depending on the level of functions performed, risks assumed, and assets used from an economic perspective. According to this concept, which is the basis of the transfer pricing analysis to be in compliance with the arm’s length principle, an entity with a lower level of functions, risks, and assets (e.g., a sales support service provider or toll manufacturer) would likely earn a lower level of profit potential, while an entity with a higher level of functions, risks, and assets (e.g., a full risk distributor or full risk manufacturer) would likely earn a higher level of profit potential.

MNEs’ business restructurings require a great deal of resources and administrative effort as they involve changes with cross-border contractual terms along with risk allocation and economic substance. For example, the parent company of a multinational group may decide to transfer shared services from a foreign subsidiary to the parent level in order to save costs. Moreover, a foreign subsidiary previously characterized as a licensed manufacturer might be transformed to a contract manufacturer to focus only on manufacturing activity without any sales to third parties.

Another example is to restructure a sales support service provider (receiving commissions that will be exposed to a special tax issue called the permanent establishment in the relevant jurisdiction) to a limited risk distributor. Business restructurings need a careful approach for the economic substance under the changed structure, conforming to each entity’s functional profile while considering the risks assumed and assets used.

Revise transfer pricing policy. Business restructurings should be simultaneously conducted with a revision of existing transfer pricing policy. Even in the absence of major restructurings such as shutdowns, mergers and acquisitions, or the establishment of a new entity, transfer pricing policies should be reviewed and revised periodically. This revision can be made based on the current transaction structure by reasonably changing the economic substance of entities within an MNE group in order to reinforce a governance factor of the ESG concept.

For the evaluation of transfer prices, each MNE entity’s expected return (profit) can be determined depending on the level of functions performed, risks assumed, and assets used from an economic perspective.

A transfer pricing analysis is required either for planning purposes before conducting any transactions (the arm’s length price setting on an ex ante basis) or for year-end compliance purposes to evaluate whether a specific fiscal year’s transfer prices conform to the arm’s length principle (the arm’s length outcome testing on an ex post basis). This analysis mostly relies on the economic principle that, similar to third-party independent companies in the market, lower-risk-bearing entities with simpler functional profiles should earn routine margins, whereas entities with higher risks may earn higher profits (or proportionate losses).

Thus, by adjusting the economic substance of entities within an MNE group, profit allocation for each of these entities should be adjusted according to the respective value chain.

September 2022 / STRATEGIC FINANCE / 31

FIGURE 3: EFFECTIVE TRANSFER PRICING STRATEGIES

Business restructurings Revision of transfer pricing policy Reestablishment of active measures Review of most recent regulation updates

Once a revision of the group transfer pricing policy is finalized, any changes should be consistently reflected in intercompany agreements. These agreements are fundamental and essential documents for proving the substance of transfer pricing transactions, especially for tax audits. MNEs may consider inserting or amending a special term into their intercompany agreements, such as a force majeure provision. Such a provision may include conditions that affect transacting parties’ profits under extraordinary or unexpected circumstances to more flexibly adjust or renegotiate transfer prices or trade terms.

Reestablish active measures. Most importantly, MNEs must prepare robust transfer pricing documentation for specific fiscal years—not only to comply with the relevant countries’ tax laws but also to reasonably describe and explain their transfer pricing positions in advance. Transfer pricing documentation is a narrative document, containing complex and often confidential quantitative and qualitative information. This documentation must synchronize with the group transfer pricing policy and intercompany agreement to prove that an MNE’s transfer price is implemented consistently and transparently. Especially for the fiscal years during COVID-19, customized documentation should explain how the global pandemic has impacted the MNE’s transfer prices and profitability as well as for the relevant industry, so its transfer prices are more reasonably evaluated.

To avoid future potential tax risks, an MNE may consider the most advanced and strategic action plan by 32 / STRATEGIC FINANCE / September 2022

Reinforcement of internal system and personnel through empowered finance and accounting professionals

implementing an advance pricing arrangement (APA).

(For an introduction to APAs, see Juan Rivera and Ken Milani’s “Strategies for Global Operations,” Strategic Finance, January 2021, bit.ly/3Jkbda3.) According to the OECD Guidelines, an APA is a type of agreement between the tax authority and the MNE made in advance of future transfer pricing transactions that outlines an appropriate set of criteria such as a method, comparables, and appropriate adjustments. Basically, it sets the critical assumptions for future determination of transfer prices for transactions over a fixed period.

Because an APA application involves active and ongoing discussions between the tax authority and MNE to determine arm’s length prices to be applied for the applicable period, it usually requires a considerable amount of administrative burden. Nonetheless, the APA application can still be beneficial since an APA approved by the tax authorities may remove operational transfer pricing risks.

For example, a large Korean electronics MNE with more than 20 foreign subsidiaries has enjoyed APA benefits for global management of operational transfer pricing risks.

The company continuously renews previously concluded APA cases and submits new applications for international transactions with other subsidiaries.

Other Korean MNEs also use APAs. To demonstrate their transparency and effective governance with regard to global tax policies as part of their ESG agenda, it isn’t uncommon to see these companies specify on their websites that they have some concluded and ongoing APA cases.

Most MNEs seek external advisor eval­uation of transfer prices for compliance and planning purposes, while the in-house practitioners implement recommendations from the external advisor evaluation.

Review recent regulatory updates. The member countries of the OECD/G20 inclusive framework on BEPS have all been continuously revising the reports on the BEPS project’s 15 actions. As part of the project, the most drastic change would be the introduction of a new digital tax under action 1, “Tax challenges arising from digitalization.” In July 2021, the member countries signed a historical reform of the international tax system with the digital tax’s two-pillar approach. Based on the OECD’s explanation, pillar 1 reallocates some taxing rights over MNEs from their home countries to the markets where they have business activities and earn profits, regardless of whether the firms have a physical

presence there. Pillar 2 seeks to put a floor on competition over corporate income tax through the introduction of a global minimum corporate tax rate of 15% that countries can use to protect their tax bases.

Because the OECD is still receiving public consultations on discussion drafts for each pillar, the details of the digital tax’s two-pillar approach may be slightly revised.

It’s still worth reading the draft reports, however, as these policies may eventually influence related industries and, thus, some MNEs will be significantly affected by their introduction. For instance, if countries around the world legislate the global minimum corporate tax rate of 15% into their domestic tax laws, MNEs that have initially set their complex global transaction structure focusing on tax savings wouldn’t benefit from such aggressive tax planning schemes anymore. Thus, those MNEs may seek to change their transaction structures to solely focus on their businesses themselves rather than to have numerous foreign subsidiaries without significant value chain activities utilized for the tax benefits. In addition to the digital tax, MNEs should closely monitor legislation of any new international tax regulations and recent tax audit trends to deal with any issues ahead of time.

Continuous Reinforcement

In general, transfer pricing policies are developed as a collaboration between external advisors and in-house practitioners. Most MNEs seek external advisor evaluation of transfer prices for compliance and planning purposes, while the in-house practitioners implement recommendations from the external advisor evaluation. Strategic finance and management accounting teams, especially those dealing with transfer pricing in global supply chains, should be well-versed in recent transfer pricing developments—rather than outsourcing or relying on the knowledge of external advisors. With the suggestions we’ve provided, strategic financial leaders in companies of all sizes and sectors can be more proactive and well-prepared in adapting transfer pricing to deal with the era of the new normal.

Of all the measures mentioned, the most important part of any transfer pricing strategy is continuous reinforcement (see Figure 3). Management accountants need to provide their insights when following up on the actual implementation and to redesign policies in accordance with the rapidly changing global environment. SF

Tae Hyoung Kim, CMA, CPA, EA, is a transfer pricing specialist at Yulchon LLC and a member of IMA’s Korea Chapter. He can be reached at taehyoung.kim.85@gmail.com. Connect with him on LinkedIn, bit.ly/3zOSrVa.

Nina Michels-Kim, CMA, CSCA, is IMA’s director of partnerships, Japan and Korea. She can be reached at nmichelskim @imanet.org. Connect with her on LinkedIn, or follow her on Twitter, @NinaMichelsKim. September 2022 / STRATEGIC FINANCE / 33

THE DOWNSIDES OF

STOCK BUYBACKS Long-term use of stock buybacks can result in negative stockholders’ equity, potentially resulting in a number of financial challenges.

BY ANDREW S. BARGERSTOCK, PH.D., CPA, AND NAVEED ABBASI

34 / STRATEGIC FINANCE / September 2022

C

ompanies continue to utilize stock buybacks as a tool to influence corporate financial conditions. According to Reuters, S&P 500 corporate common stock buybacks in the past few years have exceeded $500 billion annually (reut.rs/3BiVtCd). Initially considered a positive financial tactic, long-term use of stock buybacks (also known as stock repurchases) has caused some companies to slip into negative stockholders’ equity, which can bring a variety of financial difficulties. In recent years, companies including Boeing, Starbucks, The Home Depot, and McDonald’s have crossed a tipping point into negative stockholders’ equity as the result of many years of stock buybacks.

The continued use of this tactic has both positive and negative features. We propose a strategy for reversing the damage from negative stockholders’ equity as well as a work-around metric to replace return on equity (ROE) when it ceases to generate a meaningful measurement of

management effectiveness. With this guidance, finance professionals should be better equipped to anticipate and plan countermeasures to the possible negative effects of long-term use of stock buybacks.

Purposes of Stock Buybacks

Stock buybacks enhance shareholder value by reducing the number of shares outstanding. Consequently, earnings per share (EPS) rises and stock price will tend to increase too. If carefully planned, the buybacks should occur when stock prices are “undervalued” to make the committed buyback funds stretch further.

In the United States, the current rules from the U.S. Securities & Exchange Commission (SEC) require companies to announce their buyback plan beforehand with either the approximate dollar amount committed or the maximum number of shares to be purchased.

Buybacks must be announced and reported on any of

TABLE 1: EXAMPLES OF COMPANIES WITH HIGH ROE COMPANY

ROE

Oracle Corp.

North European Oil Royalty Trust Permian Basin Royalty Trust First Physicians Capital Group, Inc. The Home Depot, Inc. DJSP Enterprises, Inc. Amerisourcebergen Corp.

Dell Technologies DAVIDsTEA Inc. First Hartford Realty Corp.

Yulong Eco-Materials Ltd. San Juan Basin Royalty Trust Valvoline Inc. Colgate-Palmolive Co. Sabine Royalty Trust Tempur Sealy International, Inc. Mettler-Toledo International, Inc. Altria Group, Inc. Braskem

7412.75% 3213.35% 2915.23% 2635.44% 2050.28% 1864.19% 1286.11% 1246.35% 917.23% 907.66% 834.95% 816.14% 750.00% 701.20% 612.31% 574.63% 552.43% 520.03% 493.86%

Marani Brands Inc. Seagate Technology Holdings PLC

412.10% 409.94%

Source: Schwab.com; data as of May 15, 2022.

36 / STRATEGIC FINANCE / September 2022

TABLE 2: HOME DEPOT’S STOCKHOLDERS’ EQUITY AND ROE, 2013-2022 FYE

STOCKHOLDERS’ EQUITY (IN BILLIONS)

ROE

2013 2014 2015 2016 2017 2018 2019 2020

$17.8 $12.5 $9.3 $6.3 $4.3 $1.5 ($1.9) ($3.1)

26% 43% 68% 111% 184% 594% Undefined Undefined

2021 2022

$3.3 ($1.7)

390% Undefined

Note: “Undefined” when ROE denominator < 0 Source: Ruleoneinvesting.com

A major rationale for a buyback is to increase EPS, which benefits shareholders and executives.

SEC Forms 8-K, 10-Q, or 10-K to avoid insider trading risks as well as to adequately inform both shareholders and the public. Due to institutional delays in communicating buyback information, investors typically discover when transactions occurred weeks or months after they occur.

Over the past 10 years, companies have increasingly adopted stock buybacks as a tool to accomplish multiple financial objectives. One major goal is counterbalancing the dilutive effects of executive stock option exercises.

Stock option compensation plans provide incentives for company executives to personally buy common shares at a discounted rate. The executives benefit when a targeted stock price is achieved as a trigger for qualifying for stock options. When these stock options are acquired and exercised, the issuances of additional shares produce a dilutive effect on the company’s EPS. Corporate stock buybacks tend to offset the dilution by reducing the overall number of shares outstanding. In the absence of any significant executive stock options exercised, buying back shares will cause EPS to rise somewhat.

Another major rationale for a buyback is to increase EPS, which benefits shareholders and executives. Beyond the positive effects on stock price to shareholders, executives can also benefit from increases to EPS, free cash flow per share, and return on assets (ROA), all of which will tend to increase the market value of common stocks and thereby enhance the executives’ potential to qualify for even more future stock options.

September 2022 / STRATEGIC FINANCE / 37

TABLE 3: SELECTED S&P 500 COMPANIES REPORTING NEGATIVE STOCKHOLDERS’ EQUITY COMPANY American Airlines Boeing The Home Depot, Inc. HP Inc. L Brands McDonald’s Motorola Solutions, Inc. Otis Worldwide Corp.

Starbucks Verisign

TIPPING POINT 2017 2019 2019 2016 2016 2016 2015 2020 2019 2011

Source: Ruleoneinvesting.com

Potential Negative Impacts

Despite the positive effects for building stockholder wealth, long-term use of stock buybacks can produce negative effects on the balance sheet and important financial ratios.

Two potential downsides include tipping into negative stockholders’ equity and distorting the ROE leading up to and following the tipping point.

Both of these situations can be traced to the same root cause: Buyback stock prices are virtually always significantly higher than the original average issue prices of common stock. This buyback “price gap” means that each share purchased will require more funds than the amount of contributed capital originally collected when the stock was issued. Consequently, buybacks exert downward pressure on total stockholders’ equity and book value per share while increasing the possibility of technical insolvency.

A sign that a tipping point might be approaching is a dramatic increase in ROE. The long-term ROE for S&P 500 companies is approximately 14%. Normally, it’s a good metric to evaluate the effectiveness of senior management’s ability to generate a return on the capital provided by owners. In the later stages of a declining stockholders’ equity balance, however, ROE gets artificially inflated as a mathematical artifact of the decline. In the years prior to reaching the tipping point, companies experience increasingly inflated ROE. Based on our examination of historic data, if a company has been using stock buybacks for at least three to four years and the ROE exceeds 70%, it may signal a possible dip into negative stockholders’ equity in upcoming years. Table 1 provides a partial list of companies with ROE higher than 100% as of May 15, 2022. We believe these companies are at risk for tipping into negative stockholders’ equity in years to come.

38 / STRATEGIC FINANCE / September 2022

The Case of Home Depot

A good example of this is Home Depot, a company that had achieved positive profitability for more than 30 years.

The tipping alert came in 2017 and 2018 when its ROE started climbing at an accelerated rate, rising to triple-digit percentages. Then Home Depot’s ROE became mathematically “undefined” in 2019 and 2020 due to negative stockholders’ equity. In response, the company stopped buybacks for a few quarters. Combined with a strong profit year, the result was that its stockholders’ equity returned to positive.

Table 2 shows the trends in Home Depot’s stockholders’ equity and ROE from 2013 to 2022. Stockholders’ equity began at $17.8 billion in 2013, declined to $1.5 billion in 2018, and fell into negative territory in 2019. Notice how ROE became inflated, rising from 26% in 2013 to 594% in 2018. Then it became mathematically undefined (due to a denominator < 0) in three of the following four years. This shows how the balance sheet can deteriorate due to stock buybacks.

Not all companies will inevitably fall into this pattern.

The factors leading to such circumstances include (1) a large difference between common stock issue prices and buyback prices, (2) sustained pursuit of stock buybacks over a period of years, and (3) use of the retirement method for recording purchases.

According to Robert Honeywill, the number of technically insolvent companies in the S&P 500 more than tripled between 2015 and 2020, primarily due to share buybacks funded with corporate debt (bit.ly/3vuE0D3).

Buybacks are recorded by reducing stockholders’ equity.

This causes an increase in the debt-to-equity ratio, meaning that the company is funded more by debt. In addition,

Negative stockhold­ers’ equity could make it difficult to get additional loans approved.

Accounting for Stock Buybacks

companies may choose to fund buybacks by increasing long-term debt.

Negative stockholders’ equity is considered as “technical insolvency” even though the company may not have any real problem in its debt service. (See Table 3 for a partial list of S&P 500 companies that have tipped into negative stockholders’ equity.)

There are a number of possible downside effects of negative stockholders’ equity. Since negative stockholders’ equity means a company has more debts than assets, it could make it difficult to get additional loans approved and/or result in higher interest rates. Credit ratings might also suffer—though this didn’t happen with Home Depot because it continues to generate positive cash flow from operations along with consistently making debt payments.

If buybacks drive a company into negative retained earnings, the choice to declare cash dividends evaporates. Customer relations also might suffer due to concerns about the viability of continued operations. Finally, with the loss of ROE as a tool to evaluate management effectiveness, some existing or potential stockholders might back away from the investing table. (It’s worth noting that although investors tend to use ROE to evaluate performance of top management, other financial metrics are available that, when combined, may offer a more complete perspective of enterprise performance.)

For example, assume that XYZ Company issued 10,000 shares 10 years ago at $1 par value at $20 per share. The initial entry used to record the stock issue would have been: Initial public offering of common shares

To understand how to reverse the unintended negative impacts of stock buybacks, it’s important to first review the methods for recording stock repurchases under U.S. Generally Accepted Accounting Principles (GAAP). Companies generally choose either the retirement method or the cost method to record stock buybacks. (A third recording method—the par value method—is also permitted by GAAP but is rarely used, so we don’t discuss it here.) Only the cost method offers a possible path for reversing negative stockholders’ equity.

Retirement method. Under the retirement method, the repurchased shares are essentially destroyed without any intention to resell them in the future. Companies that choose this method might be signaling to the investing marketplace that either (1) the common stock price is undervalued and/or (2) they want to permanently shrink the number of common shares outstanding as a long-term strategy.

In the retirement method, stockholders’ equity is recorded by the following transaction rules: ■ The common stock account is debited by the number of shares repurchased multiplied by the par or stated value per share.

■ Additional paid-in capital is debited by the number of shares repurchased multiplied by the average per share of any additional paid-in capital from the original stock issuance.

■ Retained earnings is debited by any remaining amount needed to finalize equal debits and credits.

■ Cash will be credited as an outflow to acquire the shares.

Debit

Cash (10,000 @ $20 selling price)

Credit

$200,000

Common stock (10,000 @ $1 par)

$10,000

Additional paid-in capital (10,000 @ $19)

$190,000

Assume that this year the company buys back 1,000 shares at $60 per share. Under the retirement method, the journal entry will be: Buyback entry using retirement method Debit

Common stock (1,000 @ $1 par)

$1,000

Additional paid-in capital (1,000 @ $19)

$19,000

Retained earnings (to balance the entry)

$40,000

Cash (1,000 @ $60)

Credit

$60,000 September 2022 / STRATEGIC FINANCE / 39

Buybacks can destroy ROE as a metric to evaluate manage­ment effectiveness.

S&P 500 BUYBACK AND DIVIDEND YIELDS, 2017-2022 For every year from 2017 through 2021, the average S&P 500 buyback yield was greater than the average S&P 500 dividend yield. This shows that stock buybacks can provide more shareholder value than dividends. And the value isn’t taxed like some portions of dividends are.

(Note: The most recent version of the Inflation Reduction Act as of this writing includes a 1% excise tax on most stock buybacks.)

Notice that the common stock and additional paid-in capital accounts are reduced pro rata according to the average per-share amounts that were recorded in the original issuance journal entries. In virtually all stock buybacks, the buyback price is significantly higher than the issue price. The GAAP treatment under the retirement method is to charge any excess amount to retained earnings. If a company continues to buy back shares over many years, it could exhaust any positive balance in retained earnings.

Even with positive profits each year, the buyback effects could be larger than the positive effects of net income that might increase retained earnings as year-end closing entries. Eventually, the total of the stockholders’ equity section could become negative.

Cost method. Companies that choose the cost method will create a treasury stock contra-account within stockholders’ equity. This indicates to the marketplace that the company is likely to resell the shares at a higher price in the future and thereby dilute EPS. With the cost (or treasury stock) method, the entire amount of the cash paid to repurchase shares in our example is charged to the treasury stock account. Treasury stock is shown at the bottom of the stockholders’ equity section of the balance sheet as a deduction on the last line before the section total.

Taking the same information for the example of XYZ Company, the buyback using the cost method is: Buyback entry using the cost method Debit

Treasury stock (1,000 @ $60 par) Cash (1,000 @ $60) 40 / STRATEGIC FINANCE / September 2022

Credit

$60,000 $60,000

YEAR

STOCK BUYBACKS (IN BILLIONS)

BUYBACK YIELD

DIVIDEND YIELD

2021 2020 2019 2018 2017

$882 $520 $729 $806 $519

2.18% 1.64% 2.72% 3.84% 2.28%

1.27% 1.53% 1.81% 2.17% 1.84%

Dividend yield is calculated by the dividend amount distributed during the year divided by the company’s current or year-end or market capitalization.

Buyback yield is a key metric for assessing the benefit of stock buybacks. The yield is calculated by the amount spent during the year on buybacks divided by the company’s current or year-end market capitalization.

Data source: “S&P 500 Buybacks Set Quarterly (Q4, 2021) and Annual Record,” S&P Dow Jones Indices, March 15, 2022, as retrieved from prnewswire.com.

As a stockholders’ equity contra-account, treasury stock has a normal debit balance and should be shown at the bottom of the stockholders’ equity section as a negative number before total stockholders’ equity. In our example, it would appear as: Less: Treasury stock (at cost, 1,000 shares) $60,000 Over many years of stock buybacks recorded using the cost method, stockholders’ equity could tip into negative territory, but a large treasury stock account balance can be reversed by simply reselling shares. This provides an opportunity to reverse negative stockholders’ equity by reselling the shares.

Technically, treasury shares have been issued, but they aren’t outstanding. When they’re sold again hopefully at a higher price, it creates a nontaxable event for the corporation. The proceeds of the transaction produce an inflow of cash as it erases the treasury stock according to the number of shares repurchased. The number of shares outstanding does increase with resale, but the boost in cash may offset the dilution somewhat by boosting assets.

Let’s assume the 1,000 treasury shares are held for two years and then resold at $90 per share. The transaction would be recorded as: Resale of treasury stock at a higher price than buyback price Debit

Cash (1,000 @ $90)

Credit

$90,000

Common stock (1,000 @ $1 par)

$1,000

Additional paid-in capital (1,000 @ $29)

$29,000

Treasury stock (1,000 @ $60)

$60,000

Notice that there’s no gain on this transaction even though the 1,000 shares were sold for $30 per share more than the buyback price. Both GAAP and U.S. federal tax laws are consistent on this issue that “gains” on the sale of a company’s own treasury shares aren’t recognized.

Apple Inc. has been buying back shares since 2012 using the retirement method. From 2012 to 2017, Apple’s ROE was mostly in the 30%-40% range. As of May 2022, Apple’s ROE (trailing 12 months) was reported at 150%, signaling an alert to a possible tipping point sometime in the next few years if the company continues repurchasing common shares. Apple’s stockholders’ equity has declined to approximately 50% of its 2017 level.

Home Depot continues to use the cash method. Therefore, it could resell shares to move back to a more positive stockholders’ equity balance. Apple doesn’t have this choice.

Operating Income ROA

Buybacks can destroy ROE as a metric to evaluate management effectiveness. If ROE is mathematically undefined, then operating income ROA (OROA) is a good substitute. Although ROA is normally calculated as net income divided by average total assets, we recommend using a revised formula for ROA, which is calculated as operating income divided by average

total assets. Operating income represents a more controllable layer of profitability compared to net income.

Operating income excludes the effects of taxes, interest expense, and nonrecurring gains and losses on the sale of business units. Tax and interest expenses come from long-term business strategies that have been in place for many years. Nonrecurring gains and losses may not be the responsibility of the day-to-day managers of the business.

Anticipating the Full Impact

The long-term use of stock buybacks can lead to negative stockholders’ equity and thereby also negative book value.

Both unusual balance sheet artifacts may open the door to financial difficulties such as reduction of credit ratings, higher interest rates, loss of customer confidence, and concerns from potential investors.

The following takeaways should be helpful to finance teams: ■ If ROE rises above 70% during a period of at least three to four years of stock buybacks, this could signal possible slippage into negative stockholders’ equity.

■ Consider using the cost method for recording stock buybacks. Instead of retiring purchased shares, hold them in treasury stock, thus leaving open the possibility for reversing negative stockholders’ equity.

■ When ROE becomes artificially inflated or mathematically undefined, use OROA as the tool to evaluate management effectiveness.

■ Ensure consistently positive operating cash flow to help offset the potential impact of negative stockholders’ equity on corporate credit ratings.

Looking ahead, the SEC is expected to continue to find ways to facilitate flows of information about stock buybacks. Some of the potential changes this might lead to include: (1) shortening the current delays in reporting stock buyback information to investors, (2) enhancing the disclosure of more buyback information, and (3) restricting executives and directors from selling or purchasing stock within a specified number of days before or after the announcement of a buyback plan.

With this guidance, corporate finance teams should be in a better position to anticipate the full impact of stock buybacks and to plan countermeasures if needed to avert financial difficulties. SF

Andrew S. Bargerstock, Ph.D., CPA, is an investment educator with Rule #1 Investing LLC and an adjunct MBA finance faculty with both Norwich University and Maharishi International University. He’s also an IMA member. You can reach Andrew at andybargerstock@gmail .com.

Naveed Abbasi is assistant professor of business administration at Maharishi International University. Naveed can be reached at naveedabbasi@gmail.com.

September 2022 / STRATEGIC FINANCE / 41

REVENUE RECOGNITION AND LONG-TERM CONTRACTS

The added discretion that ASC 606 provides managers may result in more accurate and nuanced financial reporting relative to that under ASC 605.

BY GREG GAYNOR, PH.D., CPA; JOHN PALMER, CMA; SUDHA KRISHNAN, PH.D.; AND SABRINA LANDA

September 2022 / STRATEGIC FINANCE / 43

M

any companies have only recently begun implementing the updated revenue recognition guidance under Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers. Compared to the previous standard—ASC 605, Revenue Recognition—the new revenue standards can often mean key changes in the accounting for long-term contracts as well as dramatic differences in reported financial performance across time periods.

New Revenue Recognition Guidance

The Financial Accounting Standards Board (FASB) issued ASC 606 in 2014 (Accounting Standards Update 2014-09) as part of its joint project with the International Accounting Standards Board to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards.

In an acknowledgment of the primary role that revenue recognition plays in an entity’s financial performance, as well as the significant changes brought about by the new guidance, organizations were given several years before they would be required to report their results under the new standard. The initial implementation window of ASC 606 was staggered based on company characteristics (e.g., public vs. private). But in recognizing the significance of these rule changes, as well as the disruptions brought about by the COVID-19 pandemic, the FASB extended the implementation deadline for many companies by another year in 2020.

Given the importance of the new rules, along with their relatively recent adoption by many companies, the proper implementation of ASC 606 remains a highly relevant topic—especially in light of the increased employee dislocation and turnover caused by the COVID-19 pandemic.

The FASB states that “the core principle of [the guidance] is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” To achieve that core principle, the FASB provides a five-step model: Step 1: Identify the contract(s) with a customer.

Step 2: Identify the performance obligations in the contract.

Step 3: Determine the transaction price.

Step 4: Allocate the transaction price to the performance obligations in the contract.

Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.

44 / STRATEGIC FINANCE / September 2022

The key changes in ASC 606 can translate to dramatic differences in the timing of revenue, expense, and profit recognition for long-term contracts.

Applying the Guidance to Long-Term Contracts

ASC 606 supersedes the guidance for long-term contracts provided by ASC 605. Under the old guidance, companies often had the option of accounting for long-term contracts through either the completed contract method or the percentage-of-completion method (the recommended method when reliable estimates were possible). The main conceptual changes that the new guidance in ASC 606 prescribes for long-term contracts are (1) the requirements to divide a contract into separate performance obligations, assigning a transaction price to each, and (2) determining when the customer has control of the contracted good or service. These key changes can translate to dramatic differences in the timing of revenue, expense, and profit recognition for long-term contracts.

TABLE 1: SCENARIO 1 RESULTS

YEAR 1

YEAR 2

YEAR 3

TOTAL (YEARS 1-3)

REVENUE

$0

$0

$1,200,000

$1,200,000

EXPENSES

$0

$0

$600,000

$600,000

PROFIT

$0

$0

$600,000

$600,000

Scenario: Completed contract method under ASC 605

Regarding performance obligation transaction prices, the FASB states that an entity should allocate the transaction price to each performance obligation based upon its observed or estimated stand-alone selling price at contract inception. On the issue of control, an entity should recognize revenue when (or as) it satisfies a performance obligation by transferring a promised good or service to a customer. A good or service is transferred when (or as) the customer obtains control of that good or service. ASC 606 states that an entity transfers control of a good or service over time and, therefore, satisfies a performance obligation and recognizes revenue over time if at least one of the following criteria is met: 1. The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs.

2. The entity’s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced.

3. The entity’s performance doesn’t create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date.

For performance obligations that an entity satisfies (and recognizes revenue for) over time, the contractor should consistently apply a method of measuring the progress toward complete satisfaction of that performance obligation using either an output method (e.g., units of delivery) or an input method (e.g., costs incurred). If a contractor doesn’t satisfy a performance obligation over time, the performance obligation is considered to be satisfied (and revenue recognized) at the point in time when control is transferred to the customer.

Comparing Old Guidance to New

In the following hypothetical example, we demonstrate the accounting techniques for a long-term contract under both

the old (ASC 605) and new (ASC 606) revenue guidance. In doing so, we highlight key differences between the old and new standards as well as the inherent managerial discretion that now exists in revenue and expense recognition timing based on the structure of a specific long-term contract.

For this example, assume a contractor has signed a long-term contract with a customer. The estimated duration of the contract is three years. The estimated total contractor cost from the contract is $600,000. And the total contractor revenue from the contract is $1.2 million. As revenue is typically recognized when work is both completed and billed to the customer, we assume that all appropriate customer billing is made without delay.

The following scenarios illustrate the procedures for revenue recognition under ASC 605 and ASC 606.

Scenario 1: Use of completed contract method (ASC 605). Under ASC 605, contractors could choose to use the completed contract method in certain instances.

In doing so, the contractor wouldn’t need to establish who was the controlling party of the good or service during the contract period. Neither would the contractor need to separate the contract into individual performance obligations (which is the case under ASC 606). It would simply defer the recognition of all revenue and expense until the entire contract was completed. Thus, the total contract revenue of $1.2 million and total expense of $600,000 would both be recognized upon contract completion in Year 3 (see Table 1).

Scenario 2: Use of percentage-of-completion method (ASC 605). Under Topic 605, contractors commonly used the percentage-of-completion method. In doing so, the contractor wouldn’t need to establish who was the controlling party of the good or service during the contract period. Neither would it need to separate the contract into individual performance obligations. It would recognize expense periodically as contract work was completed and could measure progress using either an input method (e.g., costs incurred) or output method (e.g., units of delivery).

In our example, for simplicity, assume that progress occurs evenly over the three years of the contract. Thus, as shown September 2022 / STRATEGIC FINANCE / 45

TABLE 2: SCENARIO 2 RESULTS

YEAR 1

YEAR 2

YEAR 3

TOTAL (YEARS 1-3)

REVENUE

$400,000

$400,000

$400,000

$1,200,000

EXPENSES

$200,000

$200,000

$200,000

$600,000

$200,000

$200,000

$200,000

$600,000

PROFIT

Scenario: Percentage-of-completion method under ASC 605 (assume progress occurs evenly over three years)

in Table 2, revenue per year equals $400,000 ($1.2 million contract value divided by three years), and the expense per year equals $200,000 ($600,000 contract cost divided by three years).

Scenario 3: Identification of multiple performance obligations, recognizing revenue over time due to a customer having control of contract goods and services for the duration of the contract (ASC 606). Under ASC 606, the contractor must determine which party has control over the contract goods and services during the contract period. In addition, it must separate the contract into individual performance obligations and assign a transaction price to each based on observed or estimated stand-alone sales price.

For this scenario, assume that the customer has control for the duration of the contract. Thus, based on the FASB criteria, the contractor would recognize revenue over time (as opposed to a point in time when control is eventually transferred).

In assigning transaction prices (and costs) to separate performance obligations, unequal profit margins on the separate obligations could mean that more or less revenue might be recognized relative to cost depending on which obligation was being satisfied. In this case, the timing of revenue recognition on the overall contract wouldn’t simply mirror that of the percentage-of-completion method under the old guidance. For example, using the percentage-of-completion method, 40% of the total contract cost incurred would normally mean 40% of the revenue recognized. Under Topic 606, however, when high-margin performance obligations are completed first, 40% of total contract cost being incurred may correspond to much more than 40% of total contract revenue being recognized. (Note the inherent managerial discretion that exists in structuring long-term contracts at the outset when discussing the subsequent revenue and expense recognition from these contracts.)

For this scenario, assume that the overall contract consists of two performance obligations: ■ Obligation 1 (high-profit-margin) has a transaction price of $500,000 and $100,000 in cost.

■ Obligation 2 (low-profit-margin) has a transaction price of $700,000 and $500,000 in cost.

46 / STRATEGIC FINANCE / September 2022

Managers now have more discretion with respect to revenue and cost recognition across time periods.

Since the obligations have unequal profit margins, the amount of revenue recognized will be different based on which obligation is getting satisfied as costs are incurred.

For Scenario 3, we present two situations (see Table 3): Scenario 3A: High-profit-margin obligation satisfied first.

Assume that Obligation 1 (the high-profit-margin obligation) is satisfied by the end of Year 1 and Obligation 2 (low-profit-margin obligation) is satisfied over three years as follows: 20% in Year 1, 40% in Year 2, and 40% in Year 3.

TABLE 3: SCENARIO 3 RESULTS Scenario 3A: High-profit-margin obligation satisfied first

YEAR 1

YEAR 2

YEAR 3

TOTAL (YEARS 1-3)

$640,000 ($500,000 + $140,000) $280,000 ($0 + $280,000)

$280,000 ($0 + $280,000)

$1,200,000

EXPENSES $200,000 ($100,000 + $100,000) $200,000 ($0 + $200,000)

$200,000 ($0 + $200,000)

$600,000

PROFIT

$80,000

$600,000

REVENUE

$400,000

$80,000

Scenario 3B: Low-profit-margin obligation satisfied first

YEAR 1 REVENUE

YEAR 2

$800,000 ($100,000 + $700,000) $200,000 ($200,000 + $0)

YEAR 3

TOTAL (YEARS 1-3)

$200,000 ($200,000 + $0)

$1,200,000

EXPENSES $520,000 ($20,000 + $500,000)

$40,000 ($40,000 + $0)

$40,000 ($40,000 + $0)

$600,000

PROFIT

$160,000

$160,000

$600,000

$280,000

Scenario: ASC 606; multiple performance obligations and customer has control of goods and services (recognize revenue over time)

The recorded expense per year in this scenario is the same as Scenario 2’s percentage-of-completion method under ASC 605. In this scenario, however, both revenue and profit recognition are accelerated relative to the percentage-of-completion method because (1) the high-profit-margin obligation was satisfied more quickly than was the low-profit-margin obligation, and (2) revenue was recognized over time, as opposed to a point in time, due to the customer having control.

Scenario 3B: Low-profit-margin obligation satisfied first. In this situation, assume that Obligation 2 (low-profit-margin obligation) is satisfied by the end of Year 1 and Obligation 1 (high-profit-margin obligation) is satisfied over three years as follows: 20% in Year 1, 40% in Year 2, and 40% in Year 3.

This situation shows delayed profit recognition compared to Scenario 3A even though the low-profitmargin work is being performed more quickly than the high-profit-margin work is. The result is greatly accelerated expense recognition overshadowing mild accelerated revenue recognition and, consequently, delayed profit recognition.

Scenario 4: Identification of multiple performance obligations and recognizing revenue at a point in time due to contractor having control of goods and services for the duration of each performance obligation (ASC 606). For this scenario, assume that the overall contract consists of the same two performance obligations (with the same transaction prices and costs) in Scenario 3. The difference in this scenario is that we assume that the contractor has control of the goods and services for each performance obligation until that obligation is satisfied. At that point, control would transfer to the customer, and the contractor would recognize the revenue for the satisfied obligation. We present two situations for this scenario as well (see Table 4): Scenario 4A: High-profit-margin obligation satisfied first. Assume that Obligation 1 (high-profit-margin obligation) is satisfied by the end of Year 1 and Obligation 2 (low-profit-margin obligation) is satisfied over three years as follows: 20% in Year 1, 40% in Year 2, and 40% in Year 3.

This situation shows accelerated revenue and profit recognition compared to Scenario 2’s percentage-of-completion September 2022 / STRATEGIC FINANCE / 47

TABLE 4: SCENARIO 4 RESULTS Scenario 4A: High-profit-margin obligation satisfied first

YEAR 1

YEAR 3

TOTAL (YEARS 1-3)

$0 ($0 + $0)

$700,000 ($0 + $700,000)

$1,200,000

EXPENSES $100,000 ($100,000 + $0)

$0 ($0 + $0)

$500,000 ($0 + $500,000)

$600,000

PROFIT

$0

$200,000

$600,000

REVENUE

$500,000 ($500,000 + $0)

YEAR 2

$400,000

Scenario 4B: Low-profit-margin obligation satisfied first

YEAR 1

YEAR 2

YEAR 3

TOTAL (YEARS 1-3)

$700,000 ($0 + $700,000)

$0 ($0 + $0)

$500,000 ($500,000 + $0)

$1,200,000

EXPENSES $500,000 ($0 + $500,000)

$0 ($0 + $0)

$100,000 ($100,000 + $0)

$600,000

PROFIT

$0

$400,000

$600,000

REVENUE

$200,000

Scenario: ASC 606; multiple performance obligations and contractor has control of goods and services (recognize revenue when control transfers to customer when obligation is satisfied)

method under ASC 605. This is due to the high-profit-margin obligation being completed before the low-profit-margin obligation. Yet this situation shows delayed revenue and profit recognition compared to Scenario 3A. Because the contractor has control in this scenario, revenue recognition occurs only upon completion of the performance obligation instead of over time as in Scenario 3A. Scenario 4B: Low-profit-margin obligation satisfied first.

Assume that Obligation 2 (low-profit-margin obligation) is satisfied by the end of Year 1 and Obligation 1 is satisfied over three years as follows: 20% in Year 1, 40% in Year 2, and 40% in Year 3.

Scenario 4B shows delayed profit recognition compared to Scenario 4A. The contractor has control in both situations, but 4B shows the low-profit-margin work being performed more quickly than the high-profit-margin work.

The result is a greatly accelerated expense recognition overshadowing mild accelerated revenue recognition and, consequently, delayed profit recognition.

Figure 1 presents the potentially dramatic differences in reported income across time periods described in the 48 / STRATEGIC FINANCE / September 2022

different scenarios and situations. All of this indicates that under ASC 606, all else being equal, higher-margin work being determined to have been performed first will result in accelerated income recognition relative to the traditional percentage-of-completion method, while lower-margin work being determined to have been performed first will result in delayed income recognition.

Benefits and Risks of ASC 606

Under the new revenue recognition guidance, managers now have more discretion with respect to revenue and cost recognition across time periods than when using the traditional percentage-of-completion or completed contract methods. This stems from their need to now determine the separate performance obligations within the overall contract, the revenue and costs allocated to each, and any discretion they may have in the sequence that the obligations are determined to be satisfied. As is often the case

FIGURE 1: REPORTED PROFIT ACROSS TIME PERIODS

$700,000 $600,000 $500,000 $400,000 $300,000 $200,000 $100,000 $0

Year 2

Year 1

Year 3

Scenario 1

Scenario 2

Scenario 3A

Scenario 3B

Scenario 4A

Scenario 4B

with accrual accounting, this additional managerial discretion could enable managers to produce more accurate and nuanced financial reports relative to those under ASC 605; at the same time, it could theoretically be exploited by managers to more easily engage in earnings management or manipulation. Opportunistic managers could achieve such objectives through the initial structure of the contract and creation of specific performance obligations as well as through the obligation revenue and cost estimates and the sequence that they’re determined to be satisfied.

Due to the additional managerial discretion and nuance inherent in ASC 606, along with the central role that revenue recognition plays in reported financial performance, we believe both financial statement preparers and users benefit from a clear understanding of these significant rule changes. For managers, additional contract documentation and analysis may be warranted, especially as it relates to potential complexities surrounding, for example, the process of determining distinct performance obligations and their transaction prices.

The question of when customer acceptance or control has occurred can also require careful judgment. For their role in assessing managerial estimates, ASC 606 may justify additional documentation and analysis for auditors—who should be mindful of the potential threat to their independence in the event they become too involved in the client’s implementation of ASC 606.

We believe that the relatively recent implementation of ASC 606, coupled with the unusual economic conditions of the last couple of years, mean these new revenue recognition standards are worthy of continued focus. It may still be too early to fully identify the significant changes being brought about by their implementation. SF

Greg Gaynor, Ph.D., CPA, is an assistant professor of accounting at California State University, Long Beach and an IMA member. You can reach Greg at gregory.gaynor@csulb.edu.

John Palmer, CMA, is a lecturer at California State University, Long Beach and a member of IMA’s Orange County Chapter. He can be reached at john.palmer@csulb.edu.

Sudha Krishnan, Ph.D., is a professor of accountancy at California State University, Long Beach. You can reach Sudha at sudha.krishnan@csulb.edu.

Sabrina Landa is a lecturer at California State University, Long Beach and a member of IMA’s Orange County Chapter. She can be reached at sabrina.landa@csulb.edu.

September 2022 / STRATEGIC FINANCE / 49

THE SASB AND

SUSTAINABILITY STANDARDS Unlock the keys to position your company for success in an environmentally sensitive economy.

BY AMANDA PAVAN, PH.D., AND JERRY G. KREUZE, PH.D., CPA

50 / STRATEGIC FINANCE / September 2022

E

ven as leaders are called upon to think strategically to adjust their operations and recover from the COVID-19 pandemic, they’re now broadly expected to be aware how their company interacts with and impacts the environment.

Many investors remain committed to the environment and to investing in socially responsible companies regardless of the eco­nomic climate. The definition of “socially responsible companies” can be quite broad, but it most certainly encompasses those companies with current, dynamic, and appropriate climate positions and policies.

The Sustainability Accounting Standards Board (SASB) was created to encourage companies to report sustainability disclosures and to disclose issues that are reasonably likely to impact the financial condition or operating performance of the company. And now the U.S. Securities & Exchange Commission (SEC) is in the process of requiring disclosures on climate, human capital, and political spending. The SEC has come to the position that matters such as climate change do bear on the valuation of assets, inventory, supply chain, and future cash flows.

The Value Reporting Foundation (VRF), of which the SASB was a part, was fully consolidated under the International Financial Reporting Standards (IFRS) Foun­dation in August 2022. The SASB standards now fall under the umbrella of this new group, the International Sustainability Standards Board (ISSB), which is consolidating and building on exist­ing SASB standards and other frameworks and guidance. Thus, the SASB’s industry-specific requirements are being used as a starting point for future ISSB general, thematic, and industry-specific requirements. Until this development comes to fruition, companies are asked to continue using the SASB standards.

Management accountants often have the necessary information to facilitate these disclosures, enhancing their company’s reporting to its investors and creditors. As these reports currently aren’t part of the financial statements but likely will be in the future, management accountants who prepare for this developing requirement can add significant value to the process.

company. Notwithstanding the COVID-19 pandemic, recent pollution of various types (air, water, sound, and soil erosion) causing degradation to the environment and human health has drawn increased attention. The World Economic Forum’s Global Risks Report 2017 showed an advancement of environmental and societal risk, including extreme weather events, failure of climate change mitigation, and an increased occurrence of large-scale involuntary migration (bit.ly/3PPEz2k).

A 2017 report by the U.S. Environmental Protection Agency (EPA) estimated that continuing business-asusual will cost the United States hundreds of billions of dollars by 2050, with costs expecting to increase over time (see Multi-Model Framework for Quantitative Sectoral Impacts Analysis, bit.ly/3PQlTQ7). Businesses are facing additional environmental regulations and social impacts, and developing countries face a dual responsibility for promoting business success and prosperity and the need to protect the environment.

Organizational environmental management activities are performed internally but are also made public through sustainability reports. This disclosure should highlight the company’s progress toward protecting the environment and society, sustainability procedure and process innovations, business partner engagement, and long-term strategic planning. These activities must include management accountants as active participants since they have the necessary information and skills to add to these disclosures and decisions.

Management accountants also add value in helping to ensure that upcoming reporting requirements are satisfactorily met. For instance, proposed SEC rules include a requirement for companies to provide data on their own greenhouse gas (GHG) emissions and their energy consumption, known as Scope 1 and Scope 2 emissions. These requirements are to be phased in dependent on the registrant’s filer status. Scope 3 emissions (generated by a company’s suppliers and customers) may be required in 2024 or thereafter, with smaller companies being exempt.

Reporting by Companies

Sustainability and the increased awareness of climate change have become embedded as a critical factor in corporate business models. Addressing this challenge also applies to product development and adds value in the eyes of consumers. Green products are more attractive to many consumers, and any additional costs can frequently be passed on to those consumers to maintain the profitability of these products. But consumers are typically unaware of environmental requirements and may not want to pay for their share of those costs.

But for actual environmental problems, the willingness to pay a price premium generally prevails (see Ken Peattie, “Golden Goose or Wild Goose? The Hunt for the Green Consumer,” Business Strategy and the Environment, July/August 2001).

In fact, the 2019 Aflac corporate social responsibility (CSR) survey found that 77% of consumers are motivated to support companies with a commitment to making the world a better

Standardized sustainability reporting has recently been accelerated as an effort to minimize the exposure of failing to fully incorporate environmental and social impacts in accounting reports. In “Environmental Disclosure Quality: Evidence on Environmental Performance, Corporate Governance and Value Relevance,” George Emmanuel Iatridis argues that accounting departments discounting this reality have been criticized for facilitating increased environmental and social crises in recent decades (Emerging Markets Review, March 2013).

In order to compete in this reality, companies are expected to consider the environment in their daily global business operations. And these measures must be adequately communicated to investors and creditors to provide for full disclosure of the environmental impact of the 52 / STRATEGIC FINANCE / September 2022

Corporate Environmental Responses

place (bit.ly/3cO1nkr). A greater percentage believe it’s important for a company to make the world a better place (49%) than for a company to make money for shareholders (37%). Additionally, 61% of investors spend time researching a company’s commitment to society, and the environment contributes to a positive return on their investments. That said, company reporting is important, because only half of consumers trust companies that proclaimed to want to make the world a better place.

Societal demands aside, other stakeholders, governments, and international and other related associations are increasingly requiring the involvement of companies in preserving the environment through rules and regulations.

Reports find that one of the benefits received by socially responsible companies is a lower cost of capital and that CSR increases the investor base and reduces perceived risk (see Sadok El Ghoul, Omrane Guedhami, Chuck C.Y. Kwok, and Dev R. Mishrac, “Does Corporate Social Responsibility Affect the Cost of Capital?” Journal of Banking & Finance, September 2011). Potential investors have been found to give positive responses on companies that voluntarily disclose their green investment initiatives (see Patrick R. Martin and Donald V. Moser, “Managers’ Green Investment Disclosures and Investors’ Reaction,” Journal of Accounting and Economics, February 2016). And as Iatridis noted in Emerging Markets Review, environmental disclosures contain value-relevant information and good environmental performance causes companies to prepare more extensive environmental disclosures, eventually leading to a higher company value.

Companies with excellent environmental performance are more motivated to keep their investors and other stakeholders informed through expanded voluntary disclosures, compared to those with poor environmental performance (see Peter M. Clarkson, Yue Li, Gordon D. Richardson, and Florin P. Vasvari, “Revisiting the Relation Between Environmental Performance and Environmental Disclosure: An Empirical Analysis,” Accounting, Organizations and Society, May-July 2008). Other studies also determine a positive relationship between environmental disclosures and performance. For instance, in “Environmental and Social Disclosures: Link with Corporate Financial Performance,” Yan Qiu, Amama Shaukat, and Rajesh Tharyan find that companies get an economic benefit from preparing expanded social and environmental disclosures in the form of higher stock prices and that companies providing environmental disclosures tend to have a good reputation and are able to build a positive perception of their financial performance (The British Accounting Review, March 2016). These studies should encourage management accountants to display and report on their company’s environmental measures and performance, and that disclosure should improve the company’s profitability picture.

Environmental Information to Be Disclosed

According to the SASB, sustainability accounting begins with the identification of key costs and operational, organizational categories; the identification of areas of improvement; and implementing those improvement measures

VALUE OF SASB STANDARDS ■ Useful in evaluating how companies are managing the ESG factors that can influence financial performance ■ Industry-specific, metric-driven, and focused on financial materiality ■ Provides comparable data to impact the data and analytic ecosystem

In part, these standards can: ■ Help access corporate ESG data critical for long-term enterprise value creation.

■ Identify priority issues for corporate engagement.

■ Improve equity and credit analyses by incorporating a broader information set beyond financial statements.

■ Include sustainability risks in addition to traditional risk measures.

■ Help better understand sector-specific risks (as some sectors have more sustainability risks while others have fewer) for risk allocations and risk management.

■ Help fulfill Principles for Responsible Investment signatory commitments.

with the goal of maintaining investor, creditor, and other user satisfaction. The management accountant, being a critical part of the management team, is in an ideal position to add significant value to this reporting.

These environmental and sustainability concerns, in part, were the impetus for the creation of the SASB. This board was operated as an independent standard-setting group that established sustainable industry disclosure standards integrated with the concept of materiality to investors. In six years of operation, the SASB released 77 industry reporting standards (see “Value of SASB Standards”). The purpose of these standards is to improve communications September 2022 / STRATEGIC FINANCE / 53

The International Sustainability Standards Board is building on existing SASB standards and other frameworks and guidance.

and the reporting of sustainability issues, primarily to investors and creditors. Specifically, the SASB attempted to identify financially material issues that are reasonably likely to impact the financial condition or operating performance of a company and that are of significance to investors and creditors.

These issues are important because studies have revealed that companies rated highly on CSR and environmental, social, and governance (ESG) performance benefit from a lower cost of capital and had superior financial performance by accounting and market factors (Mark Fulton, Bruce M. Kahn, and Camilla Sharples, “Sustainability Investing: Establishing Long-Term Value and Performance,” bit.ly/3cZuMs0). According to the World Business Council for Sustainable Development, 89% of sustainability practitioners believe that failure to manage sustainability risk could significantly impact a company’s financial performance (Sustainability and enterprise risk management: The first step towards integration, bit.ly/3oKyxUG). For example, a survey of the largest 215 global companies reporting financial and environmental disclosures to the nonprofit CDP estimates that their business losses due to climate-related risks sum to $970 billion within the next five years (see Global Climate Change Analysis 2018, bit.ly/3oJIiCG).

54 / STRATEGIC FINANCE / September 2022

The SASB’s industry reporting standards are presently used by 175 companies, and those companies can use the SASB logo. This logo designation simply indicates the company used the SASB standards as a basis for some or all of its disclosures but doesn’t indicate an approval of those disclosures by the SASB. These standards align with SEC filings and comply with U.S. securities laws. These standards, in turn, allow companies to identify the most critical issues for their industry and provide a meaningful way to report on them.

Sustainability accounting disclosures have both monetary and physical units. That is, the financial performance of companies and their environmental expenditures are expressed in monetary values, but environmental performance is typically in physical units. To minimize exposure to future financial risks arising from environment incidents, companies should institute appropriate systems for the environment. These systems should promote both competitiveness and compliance and create an effective cost-benefit trade-off between expenditures and performance.

Researchers have identified some green accounting measures for companies to highlight their environmental commitments. These measures include costs of preventing air and water pollution, energy saving and global warming reduction measures, waste reduction and disposal costs, energy restoration expenditures, and research and development activities for environmental solutions.

Sustainability reporting can take various forms, including the annual report package, a stand-alone environmental performance report, a site-centered environmental statement, or some other form of disclosure. Regardless, these disclosures reflect the company’s attitude toward the environment, provide information for investors and creditors, reveal that products are appropriately priced and investment decisions based on accurate information, and exploit a competitive advantage by stressing that the company’s goods and services are environmentally preferable.

Environmentally friendly technologies should be introduced to minimize costs, especially considering cradle-to-grave cost exposures. Prevention approaches, like waste prevention, are therefore preferred to endof-pipe technologies such as waste disposal, incinerators, and remediation. Environmental capital investments must ensure that all of these cradle-to-grave implications for pollution-prevention investments are placed on a level playing field with other investment choices.

In 2016 alone, U.S. EPA enforcement actions led to companies allocating $14 billion to address pollution concerns, another $6 billion toward penalties, and more than $1 billion to clean up superfund sites. These EPA enforcement actions clearly indicate that the costs of environmental requirements must be integrated into a comprehensive cost management system and those activities are worthy of disclosure.

Benefits of SASB Standards Hundreds of companies around the world and across every sector voluntarily publish sustainability reports

WHIRLPOOL ON SUSTAINABILITY The company’s 2019 report has four major sections: 1. Expanding its United Nations Global Compact commitment 2. Commitment to science-based targets 3. Mandating strong and lasting connections with its communities 4. Our Integrity Manual: Whirlpool’s enhanced code of ethics

In Section 1, four goals are presented: ■ ■ ■ ■ ■

A 20% reduction in GHG emissions from products in use by 2030 (from a 2016 baseline) A 50% reduction in GHG emissions from plants by 2030 (again from a 2016 baseline) Zero landfill waste in all manufacturing sites by 2020 Zero fatalities and serious incidents in all manufacturing sites presently and in the future 100% full disclosure requests from all suppliers by 2020

Section 2 entails commitments to the following: ■ ■ ■ ■ ■ ■ ■

Gender equity Affordable and clean energy Decent work and economic growth Industry, innovation, and infrastructure Sustainable cities and communities Responsible consumption and production Climate actions, peace, justice, and strong institutions

Section 3 discusses potential donation causes and targets for Whirlpool and its employees.

Collaboration of Whirlpool with numerous community organizations is recognized. Section 4 is the integrity manual, which includes discussions of company cultural and principles.

addressing the SASB standards. Those companies are signaling to investors and creditors that they’re mindful of sustainability and environmental issues. Many of the reports contain similar information, so as an example of this information, we’ll look at Whirlpool Corporation’s 2019 sustainability report and the 2020 sustainability report of LG Electronics (LGE).

Whirlpool covers a number of factors in its report (see “Whirlpool on Sustainability”). Of importance is its environmental approach section. In that section, Whirlpool indicates its yearly targets in the areas of plant efficiency, carbon footprint, designing for the environment, imple-

menting circular economy across the value chain at a global level, and sustainable home innovations to enable net-zero living. Each of these programs is led by subject matter experts and has annual, three-year, and long-term goals.

Regarding waste, Whirlpool states that 96% of its waste goes to recycling, 3.5% goes to landfills, and the remaining 0.5% goes to incineration. For eight of its plants, no waste went to landfills.

Whirlpool’s product design incorporates resource efficiency attributes in planning and product design. It also maintains a restricted materials list to track the use of banned, restricted, and monitored substances of concern.

September 2022 / STRATEGIC FINANCE / 55

This list is managed and updated annually to reflect new legislation and consumer requirements. Since packaging becomes waste almost immediately upon delivery, minimal and environmentally friendly packaging is designed into the product distribution. Whirlpool has a goal of employing more than 44,500 tons of recycled plastics into its products by 2025 and is phasing out halogenated flame retardants and polyvinyl chloride (PVC) in all plastic parts and control boards by 2030.

In life-cycle design, post-consumer-recycled content packaging and material alternatives are encouraged to further reduce the company’s environmental impact.

These efforts have gained the company recognition as 17 Whirlpool-branded kitchen and laundry products received prestigious iF Product Design Awards in 2019 due to their best-in-class production efficiency, carbon footprint, social responsibility, and universal design.

In delivering products to customers, Whirlpool uses SmartWay carriers for 97% of its products. These SmartWay drivers are committed to energy efficiency and fuel economy. In disposals, Whirlpool supports a labeling system designed to provide easy-to-understand recycling instructions for consumers in North America. These efforts allow products to have a low life-cycle impact by including environmental impacts in design, production, use in home, and collection and recycling. These efforts will enable Whirlpool, according to its goals, to realize zero factory injuries, zero defects and breakdowns, and zero factory waste.

LGE, likewise, is making efforts to contribute to a sustainable society as a corporate citizen. In so doing, it plans to reduce its carbon emissions in the production stage by 50% in 2030, compared to 2017 levels. As of December 2019, seven of its production plant sites achieved ISO 50001 certification. Through its activities to save energy, LGE won the Korean Energy Award presented by the Ministry of Trade, Industry and Energy. It’s following a mid- to long-term perspective in a green product strategy that considers three elements of eco-friendliness: resources, energy, and humans.

The aim is to reduce the environmental impact of the entire product life cycle. PVC/brominated flame retardants were removed completely in 2010 from its products. The use of recycled materials has increased, and for air conditioners, the weight has been reduced and the number of fasteners reduced by 5% to make it easier to disassemble and improve recyclability.

Since 2012, LGE has followed its “eco-friendly packaging design guidelines” that include lighter packaging, reduced volume, and increased reuse and recycling of products. For waste reduction, LGE aims to achieve 95% waste recycling at its worldwide production sites by 2030.

Recognizing the importance of mutual growth with societies and sustainability in its supply chain, LGE inspects and evaluates suppliers, smelters, and refiners to mitigate the risk of social issues that may arise during the production and procurement of key raw materials and minerals.

Operationalizing these goals, LGE categorizes its suppliers into three categories (low, moderate, and high risk) based on their labor, human rights, safety, health, and environmental practices. LGE’s goal is to reduce the ratio 56 / STRATEGIC FINANCE / September 2022

of high-risk suppliers to 2% or less through continuous improvements and inspections.

By publicly stating these goals, measures, and policies, Whirlpool, LGE, and other companies reporting under SASB standards are expressing their shared goal of reducing their environmental impact and holding themselves accountable to investors, creditors, and the public. Environmentally conscious individuals can use this comprehensive information in their socially responsible investing and consuming. By presenting this data and providing these goals, Whirlpool, LGE, and others are positioning themselves as viable investments in an increasingly environmentally sensitive world. Companies presently electing not to participate in SASB reporting but that recognize the value-add of minimizing their environmental impacts should consider reporting under SASB standards. Investors, creditors, and other users will find these reports helpful in identifying and selecting among environmentally conscious companies. The willingness of these companies to publicly state their environmental and sustainability measures and goals reflects their operations and concern for the future.

The Direction of Environmental Disclosures

The SASB’s merger with the International Integrated Reporting Council into the VRF resulted in a credible, international organization that advocates integrated thinking and setting sustainability disclosure standards. This merger simplified the corporate reporting landscape by providing an attractive option for companies to display their environmental objectives and goals to users and also made it increasingly beneficial for a company to voluntarily report under these standards. But as previously mentioned, the IFRS Foundation now has the ISSB developing comprehensive global sustainability disclosures for capital markets.

This development began with existing SASB standards and guidance, and companies were instructed to continue the use of SASB standards.

The SEC is also poised to require information on climate, human capital, and political spending matters. These actions mandate companies and management accountants to accumulate the necessary information deemed of value to investors, creditors, and other users related to climate matters. Since required disclosures are on a short-term horizon, beginning and/or advancing the planning and information- and environmental-gathering phases seems a prudent approach. SF

Amanda Pavan, Ph.D., is a visiting assistant professor at the Geospatial Information Sciences program in the School of Economic, Political and Policy Sciences at the University of Texas at Dallas. She can be reached at amanda.kreuze@utdallas.edu.

Jerry G. Kreuze, Ph.D., CPA, is a professor in the department of accountancy in the Haworth College of Business at Western Michigan University. He can be reached at jerry.kreuze@wmich.edu.

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TECH FORUM | 59

TOOLS OF THE TRADE | 61

EXCEL | 62

TECH PRACTICES | 64

TECH FORUM

IS DIGITAL AMNESIA REAL?

BY MICHAEL CASTELLUCCIO

The disagreement among psychologists and neuroscientists over the seriousness of the problem is growing, but few doubt that our outsourcing of memory and certain cognitive functions to our digital devices is becoming more measurable. Whether that’s leading to a new digital category of amnesia is still uncertain.

T

Download Daniel Schacter’s study “Media, technology, and the sins of memory” in Memory, Mind & Media, Cambridge Core (bit.ly/3zTGehZ).

he outward signs are there with the insistence on more memory on our next smartphone and the absence of traditional maps in glove compartments becoming more universal, but now the interior evidence from MRI imagery and specific testing is raising concerns. In a July 3, 2022, article in The Guardian (bit.ly/3vZXgsv), Rebecca Seal pointed out that we’re clearly aware of the problem. She wrote, “Of those surveyed by memory researcher Catherine Loveday in 2021, 80% felt that their memories were worse than before the pandemic.” Seal connected this to the “smartphonification” of life, begun 20 years ago and now accelerated due to increased internet use during COVID-19. “Before smartphones,” she explained, “our heads would have held a cache of phone numbers and our memories would contain a cognitive map, built up over time, which would allow us to navigate—for smartphone users, that is no longer true.” This raises

the question: Are we now so reliant on our devices that it will change how our memories work?

In Seal’s article, neurobiology professor Oliver Hardt of McGill University described a potentially destructive cycle: “Once you stop using your memory it will get worse, which makes you use your devices even more.” He also warned that our prolonged use of GPS instead of maps, which actively engage our spatial reasoning, “likely will reduce grey matter density in the hippocampus” where spatial behaviors are processed. “Map reading is hard…. But hard things are good for you, because they engage cognitive processes and brain structures that have other effects on your general cognitive functioning.”

Another disturbing neurological study cited by Seal found changes in the brains of 10-year-olds. Using paper and pencil tests and an MRI, an ABCD (adolescent brain cognitive development) study that tracked 10,000 American children showed a September 2022 / STRATEGIC FINANCE / 59

TECH FORUM

relationship between tech use and cortical thinning. “Young children who use more tech had a thinner cortex, which is supposed to happen at an older age,” said Larry Rosen, who studies social media, technology, and the brain. Thinning, Seal explains, “is a normal part of growing up and then ageing.”

And a further problem created by smartphones is the state of constant distraction coming from notifications, texts, social media, and the anxiety of FOMO (fear of missing out). Science writer Catherine Price, in Seal’s article, called this a state of “continual partial attention.” Not only does this obstruct present awareness, but it also “impedes our brain’s ability to transfer memories from short- to long-term storage.”

THE CONTRARY VIEW Chris Bird, professor of cognitive neuroscience at the University of Sussex where he runs research by the Episodic Memory Group, explained in Seal’s article, “We have always offloaded things into external devices, like writing down notes, and that’s enabled us to have more complex lives. I don’t have a problem with using external devices to augment our thought processes or memory processes. We’re doing it more, but that frees up time to concentrate, focus on and remember other things.”

Bird isn’t alone cautioning against overreaction. Daniel Schacter, a mem60 / STRATEGIC FINANCE / September 2022

ber of Harvard’s Mind Brain Behavior Interfaculty Initiative, published “Media, technology, and the sins of memory” in July 2021. In it, he addressed the impact of media and technology on what he calls four memory sins: transience (forgetting over time), absent-mindedness (lapses in attention that produce forgetting), misattribution (attributing a memory to the wrong source), and suggestibility (implanted memories), along with growing concerns about the negative impact of media and technology on memory.

Schacter admitted, “Negative impacts have been documented, but they are mostly what I have called processspecific effects, with limited evidence of domain-specific [far-reaching] effects and no evidence for domain-general effects [damage to overall memory processes]. Moreover, some positive impacts have also been documented….

Thus, we should approach broad claims about the damaging effects of technology and media on memory with caution.” The 15-page paper deserves serious consideration.

These are just a few representative speculations of where the controversy is now. Expect the dialogue to get more complicated going forward, especially in those areas of AI development where machine encroachment becomes even more humanized. SF

“What we pay attention to in the moment adds up to our life.”

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The transition from desktop to laptop to the 2-in-1 tablet takes another step forward with Microsoft’s Surface Pro 8 for business.

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form. Biometric sign-in has Windows Hello, and the Pro Signature Keyboard has fingerprint ID, mechanical backlit keys, and a glass touchpad. A storage space on the keyboard provides wireless charging for the Surface Pen. www.microsoft.com

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Keep up with the ­latest tools and trends in ­technology with SF TECHNOTES, now a semimonthly blog at SFmagazine .com.

September 2022 / STRATEGIC FINANCE / 61

EXCEL

NEXT LARGER ITEM WITH XLOOKUP The XLOOKUP function was added to Excel in 2019 as an improvement over the VLOOKUP or INDEX/MATCH functions.

There are many benefits that make XLOOKUP safer and more flexible than the legacy functions, including the ability to find the next larger item when an exact match isn’t found in the table.

BY BILL JELEN

See more figures for this story at:

SFmagazine.com

62 / STRATEGIC FINANCE / September 2022

A NEW OPTION Consider the adventure tour company shown in Figure 1. As it takes a reservation, it finds out the name of the person and the number of people in the party. It will need to find the correct vehicle from the lookup table shown in F4:H9. The matching technique is that you need a vehicle that can accommodate the number of passengers. If there are 1, 2, or 3 passengers, they can fit in a car.

For 4 or 5 passengers, you need to reserve the SUV. Notice that the lookup table is arranged alphabetically by vehicle name instead of sorting by the passenger count.

The lookup for Barb’s group in row 6 is easy. Her party has 14 people, and the white van in row 9 of the lookup table seats 14 people. This is an exact match and something that was possible with VLOOKUP or MATCH. The situation is more complicated with Andy’s party of 9 in row 5. There are no vehicles in the lookup table that seat exactly 9. The old VLOOKUP had an

option that could find the value just less than 9, but a van that seats 7 isn’t going to work for this group.

The old MATCH function had an option to look for the next larger item, but it only worked if the lookup table was sorted in descending order by the numeric column.

VLOOKUP pros will recognize another problem: You’re looking for the passenger count in column H and need to return the vehicle and cost from columns that are found to the left of the lookup column. VLOOKUP was built on the assumption that return value was always to the right of the lookup value.

XLOOKUP is able to find the exact match or next larger item by using a match mode of positive 1, as shown in Figure 2.

A CAUTION FOR MATCH USERS For people who have used the MATCH function to find values equal or greater than the lookup value, you should carefully note the difference with the XLOOKUP match mode.

In the legacy MATCH function, a positive 1 would return a value less than, and a negative 1 would return a value greater than.

Today, those directions seem backward. Why would you specify a negative number if you want to return a value larger than the lookup value? We don’t need to get into the arcane history of why they’re backward. The upside is that, with the new XLOOKUP function, Joe McDaid on the Excel team figured he could correct the meaning of positive 1 and negative 1 for the function’s match mode. As shown in Figure 2, a 0 means exact match, -1 means next smaller, and 1 means next larger. I wholeheartedly agree with this correction.

MOVING FROM VLOOKUP TO XLOOKUP For those of you who are more used to VLOOKUP, there are a couple of simple changes to switch from VLOOKUP to XLOOKUP. Both functions start the same by providing a lookup value in the first argument.

The differences come in the second

and third arguments. For VLOOKUP, you would specify a rectangular table array and then an integer column number. For XLOOKUP, the second argument is a single column used as the lookup array and then a single column used as the return array.

In the formulas shown in Figure 1, I skipped the optional fourth argument where you can specify what to return if something isn’t found. I actually wanted the #N/A errors shown in C12 and D12 to alert someone that there aren’t any vehicles to accommodate a tour with 66 passengers. You might prefer to return “Call Jo” instead of the N/A error. In that case, the fourth argument could be used: =XLOOKUP($B5,$H$5: $H$9,$F$5: $F$9,"Call Jo",1).

Everything is working to return the vehicle needed. When you copy the formula from C5 to D5 in order to return the cost of that vehicle, there’s a great technique to change the formula. With VLOOKUP, you would have changed the integer column number from 1 to 2 in order to point to the cost column.

With XLOOKUP, you need to change $F$5:$F$9 to $G$5:$G$9. Select the copied formula in D5, then press F2 to edit. Using the mouse, drag the edge of the purple outline that surrounds the vehicle names and drop it on the vehicle costs.

Formula pros will recognize that had the original formula used F$5:F$9 instead of $F$5:$F$9, the formula would have copied correctly and automatically pointed to the cost column.

Looking up the next larger value, even when the lookup table isn’t sorted, is just one of the many benefits of XLOOKUP over the legacy alternatives.

It’s available in Microsoft 365 and Office 2021 versions of Excel. SF

Bill Jelen is the host of MrExcel.com and the author of 67 books about Excel. He helped ­create IMA’s Excel courses on data analytics (bit.ly/2Ru2nvY) and the IMA Excel 365: Tips in Ten series of micro­learning courses (bit.ly/2qDKYXV). Send questions for future articles to IMA@MrExcel.com.

Figure 1

Figure 2

Finding the next larger item is just one of the many benefits of switching from VLOOKUP to XLOOKUP.

September 2022 / STRATEGIC FINANCE / 63

TECH PRACTICES

STORYTELLING IN DATA STRATEGY

BY FATEMA EL-WAKEEL, CMA

Storytelling can be a powerful way to convey your data strategy to your organization’s key stakeholders.

G

etting stakeholders on board is critical for any new project, and having supportive stakeholders ensures your department’s hard work is recognized. Data strategy is an increasingly vital function within any organization and can cover scaling analytics; creating strategies for current and future technologies such as AI, blockchain, and digital twins; and ensuring that the organization makes the best use of its data. A data strategy isn’t just about the data itself: It’s about communicating the value that can be generated through data from cradle to grave.

While emerging technology is always exciting and enticing, storytelling can effectively express a sound data strategy—determining and communicating what’s essential for your organization. Introduced technology should be relevant to the current and future data usage and the organization’s overall strategy, and should align with the organization’s analytics and technological maturity. Several common areas engaged in contemporary data strategy are the following: ■ AI: allows machines to learn from data and apply that learning to perform tasks and execute processes using human-like thought patterns ■ Analytics: the use of technology to discover, interpret, and communicate patterns, relationships, and connections in data ■ Blockchain: a means to record digital transactional data and distribute it in a peer-to-peer network ■ Digital twin: a virtual replication of an object or system to help with decision making ■ Metaverse: the use of an immersive virtual world to facilitate connection in a digital reality

64 / STRATEGIC FINANCE / September 2022

THE ART OF STORYTELLING Not everyone understands data, but everyone understands a story. Matthew Luhn, whose credits include the Toy Story films, Finding Nemo, and many more, suggests finding hooks that can be used to gain the attention of your audience.

1. The unusual: This is when you start your story with an unusual example to interest users in learning more about your project. For example, what if you can slice and dice data you have in a leadership meeting and get answers without waiting on the team to update visualizations?

What if you create a data asset that’s accessible to all employees with the right security levels to enable better reporting self-service?

2. The unexpected: This is when you surprise your users, sharing something with them that they aren’t expecting or accustomed to hearing.

What if the data team can create a model for the business that tells it what to source from which country to which factory around the world?

3. Conflict/action: This involves the identification of a conflict or challenge and can be couched as a call to action. If we know that the organization is struggling to hire data engineers, visualization specialists, and other data talents, for example, the upskilling of internal staff can offer training and resources through storytelling to get stalled projects up and running.

Anyone who has attended a meeting and thought, “I can see that this is relevant to my area, but I didn’t really understand the content because it was too technical,” can appreciate that storytelling is an art. There are few best practices that can help communicate dense data, whether in a presentation, a proposal, or even an email to share data strategy with other stakeholders.

TAILOR TO YOUR AUDIENCE Make it personal and relatable: Make sure you know your audience before your presentation, project pitching, or meeting. You can use LinkedIn and other social media platforms to know them better. Ensure that you’re relatable when sharing information with them.

Though most audiences won’t be interested to read the code or to look at the breakdown of numbers, the same information can often be conveyed in a visual format.

No matter how complex the data set is or how technical the information you’re trying to convey, remember you’re dealing with people, regardless of what level of the organization they’re in. Tell the data story in an authentic voice and with genuine interest in the key takeaways.

REMOVE IRRELEVANT DETAILS Particularly if your audience isn’t technical, be sure to include only enough technical information to make it understandable. On the other hand, if your audience is very technical, then take them with you on the journey by diving into the technical details.

If you’re sharing a forecasting model that’s created through the coding language Python, for example, and you know your audience members aren’t coders, avoid detailing lines of code

and explaining the testing. Instead, explain how the forecasting was done covering criteria, confidence levels, and other relevant data. If you’re speaking to members of the finance data and analytics center of excellence, you might want to go through the robustness of the model and testing done. They would love to get technical.

MAKE IT VISUAL Though most audiences won’t be interested to read the code or to look at the breakdown of numbers, the same information can often be conveyed in a visual format. Use graphs, figures, or even just pictures that you can speak to. A picture speaks a thousand words.

If you put lines of code on the screen, the nontechnical people will be switching off and not listening, and even the technical audience might get lost reviewing the code and stop listening to you. Include the positive impact. For example, how will this project support moving ahead of our competitors? Or how will it make the organization improve?

Data strategy is shaping the future of today’s organizations. Future technologies such as Web3 and the metaverse are developing as you read this article. Not everyone will be interested in these developing technologies, but we’ll all be operating within or alongside them. This is why storytelling is crucial. It helps land the right message and get the audience interested. Have you used storytelling in your data strategy? I would love to hear your thoughts and experiences. SF

Fatema El-Wakeel, CMA, leads the Global Data Platforms at Unilever. She’s also a member of IMA’s Global Board of Directors and IMA’s Technology Solutions and Practices Committee. You can reach her on LinkedIn, bit.ly/3Qmix7n.

September 2022 / STRATEGIC FINANCE / 65

LIFE

A Positive Change

BY ANOOP AGRAWAL, CMA

A Anoop Agrawal, CMA, is an internal control analyst at PayPal India and a member of IMA’s Bangalore Chapter.

You can reach him at anoop1546 @gmail.com.

FTER COMPLETING MY BACHELOR’S DEGREE, with a focus on accounting, at the University of Jabalpur, I spent the first 15 years of my career working in the diversified business sector. As I gained practical work experience, my role progressed from basic accounting jobs to the finance manager level.

Despite this professional success, there was still one major career goal that I hadn’t fulfilled: It had always been my dream to work in a global Fortune 500 company.

I had solid work experience, but I felt that my lack of an international certification was an obstacle to achieving my goal (early in my career, in fact, I had spent some time trying to earn a certification but had ultimately put aside that pursuit). The turning point came a few years ago when I faced a setback while working with a multinational corporation in Africa. I was being considered for a promotion to country finance controller but didn’t get the position because it required holding either the chartered accountant (CA) or CMA® (Certified Management Accountant) professional certification. Instead, I had to settle with the position of country finance manager. This incident was the motivation I needed to seek out a globally recognized professional certification.

After thorough research, I decided to pursue the CMA. I especially appreciated that you could use course materials—available in both book and

66 / STRATEGIC FINANCE / September 2022

online formats—provided by renowned study partners. I also found it helpful that the exams could be taken at well-run, professionally staffed testing centers around the world and that you could select a time to take the exams that was convenient for your schedule.

Becoming an IMA® member and pursuing the CMA was the best professional decision I’ve made.

Now I’m able to keep up with the latest finance and accounting techniques, especially those related to information technology in accounting software and other similar fields.

My CMA exam preparation helped me in generating and providing reliable management information system reports and product costing to management. In very little time, I became a trusted partner in decision making. I was also inducted as a change management leader of the company’s enterprise resource planning software implementation team thanks to knowledge I gained while preparing for the CMA. Having earned my CMA in 2021, I feel more confident because I have expanded my skills in capital budgeting, variance analysis, internal controls, risk assessment, and information technology. The certification has opened pathways for me to apply for positions globally, giving me confidence to accept these challenging roles with no restriction on geographic boundaries. As a CMA, I look forward to continuing to pursue C-level executive roles.

My experience taught me that it doesn’t matter which phase of your career you’re currently in.

Earning the CMA certification will bring about a positive change to your life and career. SF

« Becoming an IMA member and pursuing the CMA was THE BEST PROFESSIONAL DECISION.»

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