TOPICS FOR CFO

1
TOPICS FOR CFOS Current Tax Topics Roger
Poulin, Principal Proposed FASB Lease Accounting
Changes Nick Ireland, Senior Manager Recap on
New Allowance Disclosures Matt Prunier, Manager
2

• Current IRS Audit Issues

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IRS Audit Issues

• Deducting OREO Carrying Costs
• There have been a growing number of examinations
  in which the IRS has sought the capitalization of
  OREO carrying costs
• The IRS argument is based upon an assertion that
  the OREO property is inventory acquired for
  resale and, consequently, 263A requires all
  carrying costs to be capitalized to the basis of
  the individual properties (which would permit
  them to be deducted upon disposal of the
  applicable properties)
• The IRS position appears to be coordinated

4
IRS Audit Issues (continued)

• Deducting OREO Carrying Costs
• The taxpayer argument in support of deducting
  these costs as they are incurred is based upon an
  assertion that the OREO properties are not, in
  fact, inventory
• Instead, the properties are acquired in the
  ordinary course of the loan relationship in order
  to mitigate the potential loss on the worthless
  debt obligation, not to be sold at a profit
• Such an argument would support the deduction of
  the OREO carrying costs as an ordinary and
  necessary business deduction under 162

5
Cease Accrual of Interest

• Cease accrual when determined to be uncollectible
• When charge-off occurs
• There exists no reasonable expectation at the
  time of accrual that the items of income will be
  collected (Rev. Rul. 80-361 also see Rev. Rul.
  2007-32)
• For example, where it can be demonstrated that
  the borrower was insolvent at the time the right
  to accrue the interest arose

6
Bad Debt Rules for Financial Institutions

• For banks under IRC Sec. 581
• Partial bad debt
• Bad debt conformity election (Reg. 1.166-2(d)(3))
• Rev. Rul. 2007-32
• Safe harbor method of nonaccrual interest (Rev.
  Proc. 2007-33)
• General rules apply in absence of these special
  elections (Reg. 1.166-2(a))
• Based on all pertinent evidence
• Legal action not required
• Bankruptcy generally indication of worthlessness

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Bad Debt Conformity (Reg. 1.166-2(d)(3))

• Presumption that a charge-off for regulatory
  purposes is correct
• Loan must be classified as a loss asset for
  regulatory purposes
• Provides IRS audit protection of charge-offs
• Must obtain determination letter from federal
  regulator (see Rev. Proc. 92-84)

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Bad Debt Conformity (Reg. 1.166-2(d)(3))
(continued)

• Election made bank-by-bank
• Treated as an adoption or change in method of
  accounting
• For new banks automatic change (as opposed to
  manual) for first election
• Cut-off approach, so no Sec. 481(a) adjustment

9
Revenue Ruling 2007-32 Non-accrual Interest

• Deals with accrued but uncollected interest when
  the bank has made conformity election under Reg.
  1.166-2(d)(3)
• Extends conformity election to nonaccrual
  interest
• Holds that without a conformity election
• Accrued but unpaid interest must be recognized
  for tax purposes, even when loan is charged-off,
  when some expectation of payment
• Remedy is bad debt deduction for accrued but
  unpaid interest in year of charge-off
• Subsequent payment goes to interest first

10
Fixed Asset Depreciation

• The 50 bonus depreciation provisions have been
  extended for qualified property placed in service
  before 1/1/2013
• However, the bonus depreciation amount is
  increased to 100 for qualified property acquired
  after 9/8/2010 and placed in service before
  1/1/2012
• Guidance is provided in Revenue Procedure 2011-26

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Fixed Asset Depreciation (continued)

• Qualified property for both provisions generally
  includes all depreciable fixed assets and
  software, but does not include buildings and
  their structural components
• However, certain leasehold improvements made to
  the interior of a leased building may qualify if
  the building is more than three years old
• Bonus depreciation only applies to new property
  (not used), but 179 applies to both new and used
  property
• Cost segregation opportunities abound for
  construction projects, especially those placed
  into service in 2011 and 2012

12

• Maine Tax Credits

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Maine Bonus Depreciation / Credit

• Bonus Depreciation - Maine Capital Investment
  Credit
• For tax years beginning in 2011 and 2012, Maine
  will allow a credit equal to 10 of federal bonus
  depreciation claimed by businesses for new
  property placed in service in this State
• Credit is nonrefundable, but unused amounts may
  be carried forward for 20 years
• The bonus depreciation upon which the credit is
  based must be added-back for Maine purposes
  (except for composite filings addressed later)
• Credit is subject to recapture if the property is
  not used in Maine for 12 months after being
  placed in service.
• Section 179 Conforms to federal in 2011
• Beginning in 2011, Maine will follow federal law
  regarding Sec. 179 depreciation. The maximum
  deduction for 2011 will be 500,000

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Maine Seed Capital Credit

• Seed Capital Credit
• Program administered by the Finance Authority of
  Maine (FAME)
• Investments made prior to 1/1/2012 - a tax credit
  certificate may be issued by FAME in an amount
  not more than 40 of the cash actually invested
  in an eligible Maine business in any calendar
  year, or in an amount not more than 60 of the
  cash actually invested in any one calendar year
  in an eligible Maine business located in a
  high-unemployment area, as determined by FAME
• For investments made or after January 1, 2012, a
  tax credit certificate may be issued to an
  investor other than a private venture capital
  fund in an amount not more than 60 of the amount
  of cash actually invested in an eligible Maine
  business in any calendar year

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Maine Seed Capital Credit (continued)

• Eligible Business
• Must be located in Maine
• It must be a manufacturer must provide a product
  or service that is sold or rendered, or is
  projected to be sold or rendered, predominantly
  outside of the State must be engaged in the
  development or application of advanced
  technologies must be certified as a visual media
  production company Program administered by FAME
• Must have annual gross sales of 3MM or less
• The operation of the business must be the
  full-time professional activity of the principal
  owner

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Maine Seed Capital Credit (continued)

• Eligible Investments/Investors
• Aggregate investment eligible for tax credits may
  not be more than 5MM for any one business as of
  the date of issuance of a tax credit certificate
• Investment for which any individual is applying
  for a tax credit certificate may not be gt 500K
  in any one business (can be invested over 3
  consecutive calendar years). (This does not limit
  other investment by any applicant for which no
  tax credit certificate is being sought.)
• The principal owner / principal owner's spouse
  are not eligible for a credit
• A tax credit certificate may not be issued to a
  parent, brother, sister or child of a principal
  owner
• Investors qualifying for the credit must each own
  lt 1/2 of the business
• The investment must be at risk for 5 years
• Specific rules apply for investments through
  private venture capital funds

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Maine Seed Capital Credit (continued)

• Utilization of Credits
• Credit calculated / approved by FAME shown on
  Certificate issued
• Must be used 25 per year
• Amount used cannot exceed 50 of tax liability
  before the credit
• Carry forward of 15 years
• Investments made through private venture capital
  funds after 1/1/2012 may be eligible for
  refundable credits. (Specific rules apply.
  Credit to be calculated by FAME.)

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Maine Pine Tree Development Zone

• PTDZ Income Tax Credit Basics
• Tier 1 business location (other than Cumberland
  or York Counties) 100 credit in years 1 5
  50 credit in years 6 10
• Tier 2 location 100 credit in years 1 5
• Credit is calculated by computing an
  apportionment percentage PTDZ payroll
  property of business activity / total payroll
  property of business activity multiplied by tax
  credit. (Also compute credit against ME
  minimum tax)
• When calculating percentage attributable to PTDZ
  activity from a PTE, make sure to include the
  shareholders PTDZ eligible wages in the PTDZ
  income allocable to him/her
• No carry forward

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Maine Rehab. Of Historic Properties

• Tax Credit
• Applies to qualified expenditures made from
  1/1/2008 12/31/2023
• Credit equal to 25 of the taxpayer's certified
  qualified rehabilitation expenditures for which a
  tax credit is claimed under Section 47 of the
  Code for a certified historic structure located
  in ME (a copy of Part 3 of the Historic
  Preservation Certification Application signed by
  the Natl. Park Service and federal form 3468
  must be attached) or
• 25 of the certified qualified rehabilitation
  expenditures of a taxpayer who incurs not less
  than 50,000 and up to 250,000 in certified
  qualified rehabilitation expenditures in the
  rehabilitation of a certified historic structure
  located in ME and who does not claim a credit
  under the Code, Section 47 (a copy of Part 3 of
  the small project rehab certification application
  signed by the ME Historic Preservation Commission
  must be attached.)
• Credit increased to 30 for a certified
  affordable housing project
• Total credit limited to 5MM
• Credit fully refundable equally over 4 years

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Maine New Markets Capital Investment Program

• Tax Credit
• Modeled after Federal NMTC program
• Administered by FAME
• Maine credit of up to 39 to investors in
  qualified community development entities
  investments on or after 1/1/2012
• Credit taken over 7 years 0 in years 1 and 2,
  7 year 3, 8 years 4 through 7
• Taxpayers may elect to make the credit
  refundable, or carry forward for up to 20 years
• Recapture rules apply
• Awaiting guidance from MRS and FAME

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Maine Credits Summary
22
Questions
23

• Proposed FASB Lease Accounting Changes

24

• Does it make sense that an airlines balance
  sheet doesnt show airplanes?

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FASB/IASB Convergence Project

• FASB and IASB are jointly working on several new
  standards. Why?
• The Boards desire to improve existing U.S. GAAP
  and IFRS
• To reduce the gap between U.S. GAAP and IFRS to
  allow for less pain if U.S. does move to IFRS in
  the future
• Lease accounting is one of four remaining major
  areas in which FASB and the IASB are trying to
  reach convergence in standards.
• A separate but related project to the SECs
  potential adoption of IFRS.

26
Exposure Draft - Leases

• Original Exposure Draft was issued in August
  2010.
• Original target date was June 2011.
• Hundreds of comment letters and significant
  outreach
• The Boards have punted issuance several times as
  the topic has been debated at just about every
  meeting since

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Exposure Draft Leases (continued)

• The key redeliberations topics relate to
• Scopes (leases of inventory or of internal use
  software)
• Definition and measurement
• Accounting for modifications/extinguishments,
  subleases, and leasehold improvements
• Presentation and disclosure
• Transition and effective date
• The revised exposure draft is expected to be
  released in second half of 2012.
• Well just have to stay tuned.

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Fundamental Proposals

• Lessees will record all leases on their balance
  sheet similar to how lease accounting is
  currently done for capital leases
• Liability will be recorded for lease obligations
• Asset will be recorded for right-to-use asset,
  which will be amortized
• Interest expense will be recorded relating to the
  obligations using the effective interest method
• There will be some shortcuts allowed for short
  term leases
• New disclosures

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Comparison at a Glance

• Current GAAP Operating
• Balance Sheet n/a
• Income Statement Rent expense
• Current GAAP Capital
• Balance Sheet Asset and liability
• Income Statement Depreciation and interest
  expense
• Proposed All leases
• Balance Sheet Right-to-use asset and liability
• Income Statement Amortization and interest
  expense

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Recognition of Liability and Asset

• Lease obligation liability
• Record at present value of lease payments
• Recognize interest using the effective interest
  method
• Right-to-use asset
• Generally equal to obligation liability plus
  initial direct expense minus lease incentives
• Amortize over the shorter of the lease term or
  estimated useful life. Most entities will
  probably use SL method.
• Assess for any indications of impairment at each
  reporting period
• If purchase option is likely to be exercised then
  amortize over useful life.

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Present Value of Lease Payments

• Measure the present value using
• An expected outcome technique
• A discount rate at the lessees incremental
  borrowing rate
• Need to include the following in lease payments
• Estimated contingent rents payable
• Estimated amounts payable under residual value
  guarantees
• Estimated expected payments to lessor under
  nonrenewal optional penalties
• Exercise price of purchase option (only if lessee
  has significant economic incentive to exercise
  the option)

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Contingent Payments

• The lease payments should include the following
• Payments that depend on an index rate
• Payments that meet a high recognition threshold -
  such as reasonably certain
• Reassess estimates at each reporting period
• Differences between actual and estimated
  payments
• If the changes relate to current period then
  record in the PL
• If the changes relate to future periods then
  adjust the balance sheet

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Contingent Payments (continued)

• Many comment letters relate to disagreements with
  the Exposure Drafts treatment of
• The expected outcome approach
• Uncertainty of payments
• Subsequent deliberations decisions on contingent
  rents
• Eliminate expected outcome approach and use the
  best estimate approach instead
• Do not include contingent rent based on usage
• Do include contingent rent based on index
• Do include payments that meet a high recognition
  threshold (reasonably certain)

34
Lease Term

• What is the appropriate lease term?
• The longest possible term that is
  more-likely-than-not to occur (gt50)
• Consideration must be given to all relevant
  factors
• History
• Existence of renewal options and renewal rates
• Termination penalties
• Importance of underlying leased asset(s) to
  lessees operations
• Significance of leasehold improvements
• Many comment letters relate to disagreements with
  the Exposure Drafts definition of lease term
• Recognizing amounts that dont meet the
  definition of a liability
• Its highly subjective potential for
  manipulation

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Short-term Leases

• Certain shortcuts will be allowed
• Short-term lease maximum possible term,
  including any renewal options, of 12 months or
  less
• Exposure Draft says that lessees may elect to
  measure lease assets and liabilities on an
  undiscounted basis
• Subsequent deliberations decision lessees may
  elect to treat an operating lease
• No right-of-use asset or lease liability
  recognized
• Recognize payments on a SL basis

36
Transition

• There will be no grandfathering
• All existing leases will be recognized using a
  simplified retrospective approach
• Adjust opening balance equity for the prior
  period as if policy has been applied from the
  beginning (of the earliest period presented)
• Operating leases
• Liability to the PV of the remaining lease
  payments
• Discount rate to the incremental borrowing rate
  on the date of application
• Adjust right-of-use asset for any prepaid or
  accrued lease payments
• Capital leases
• Carry forward existing liability and asset
  balances

37
Presentation

• Balance sheet
• Present the liability on its own line
• Present the right-to-use asset in with PPE but
  separately from non-leased assets
• Income statement
• Present amortization and interest expense from
  other amortization and interest expense (either
  in the PL or footnotes)
• Cash Flows
• Present lease payments as financing activities
  and show them separately

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What does this mean for you?

• Your Bank
• Start addressing and analyzing now
• The grossing-up of the balance sheet will
  negatively impact risk-based capital ratios.
• Differences between tax and book could result in
  DTA or DTLs
• Adjustments for changes in estimates will result
  in increased balance sheet volatility
• Different expense profile instead of having a
  SL of expense there will be more expense recorded
  earlier and less later (due to interest on the
  unwinding of the liability)

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What does this mean for you? (continued)

• Your Borrowers
• Could have a detrimental impact on working
  capital ratios
• Potentially could have significant impacts on
  covenant compliance - both good and bad
• Increased EBITDA
• Worsened financial statement ratios such as net
  worth ratio
• Increased balance sheet volatility

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Questions
41

• Recap of ASU No. 2010-20
• New Allowance Disclosures

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Who does this Effect?

• All entities, both public and nonpublic with
  financing receivables.
• For public entities, effective for periods ending
  on or after December 15, 2010
• For non-public entities, effective for periods
  ending on or after December 15, 2011
• Excludes
• Short-term trade accounts receivable
• Receivables measured at fair value / measured at
  the lower of cost or fair value.

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What is the Purpose of the Update?

• Quoted from the ASU
• This Update is intended to provide additional
  information to assist financial statement users
  in assessing an entitys credit risk exposures
  and evaluating the adequacy of its allowance for
  credit losses.
• What this means for you
• No new accounting requirements, rather a
  significant expansion of disclosure.

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Main Provisions

• Provide disclosures which allow the reader to
  evaluate
• The nature of credit risk inherent in the
  entitys portfolio of financing receivables
• How that risk is analyzed and assessed in
  arriving at the allowance for credit losses
• The changes and reasons for those changes in the
  allowance for credit losses

45
Amendments to Existing Disclosures

• A rollforward schedule of the allowance for
  credit losses on a portfolio segment basis
• For each portfolio segment the related recorded
  investment in financing receivables
• The nonaccrual status of financing receivables by
  portfolio segment
• Impaired financing receivables by portfolio
  segment

46
New Reporting Requirements

• Credit quality indicators of financing
  receivables by portfolio segment
• The aging of past due financing receivables by
  portfolio segment
• The nature and extent of troubled debt
  restructurings that occurred during the period by
  portfolio segment
• The nature and extent of financing receivables
  modified as troubled debt restructurings within
  the past 12 months that defaulted during the
  reporting period
• Significant purchases and sales of financing
  receivables during the reporting period by
  portfolio segment

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Allowance Roll
Consumer Commercial Loans Commercial Mortgage Residential Un-allocated Total
Beginning 2 8 6 4 1 21
Charge-offs - (2) (2) (1) - (5)
Recoveries - 1 1 - - 2
Provision (1) 4 5 1 1 10
Ending 1 11 10 4 2 28

Individually evaluated for impairment - 2 4 1 - 7
Collectively evaluated for impairment 1 9 6 3 2 21

Loans Ending 100 1,100 1,000 400 - 2,600
Individually evaluated for impairment - 400 500 100 - 1,000
Collectively evaluated for impairment 100 700 500 300 - 1,600
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Past Due and Non Accrual
30 30 30 60 90 90 Past Due Current Total 90 Accrual 90 Accrual
Consumer Consumer 10 10 10 10 - - 20 80 100 - -
Commercial loans Commercial loans 150 150 150 100 50 50 300 800 1,100 - -
Commercial mortgages Commercial mortgages 200 200 200 50 50 50 300 700 1,000 - -
Residential Residential 35 35 35 5 10 10 50 350 400 10 10
Total Total 395 395 395 165 110 110 670 1,930 2,600 10 10

As of December 31, 2011, loans on nonaccrual status consisted of the following As of December 31, 2011, loans on nonaccrual status consisted of the following As of December 31, 2011, loans on nonaccrual status consisted of the following As of December 31, 2011, loans on nonaccrual status consisted of the following As of December 31, 2011, loans on nonaccrual status consisted of the following As of December 31, 2011, loans on nonaccrual status consisted of the following As of December 31, 2011, loans on nonaccrual status consisted of the following As of December 31, 2011, loans on nonaccrual status consisted of the following As of December 31, 2011, loans on nonaccrual status consisted of the following As of December 31, 2011, loans on nonaccrual status consisted of the following As of December 31, 2011, loans on nonaccrual status consisted of the following As of December 31, 2011, loans on nonaccrual status consisted of the following As of December 31, 2011, loans on nonaccrual status consisted of the following

Commercial loans 50 50
Commercial mortgages 50 50
100 100
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Risk Ratings
Commercial Loans Commercial Mortgages Total
Pass 500 450 950
Watch 300 350 650
Special Mention 150 100 250
Substandard 150 50 200
Doubtful - 50 50
Loss - - -
1,100 1,000 2,100




50
Performing Non Performing
Consumer Residential Total
Performing 100 400 500
Non-performing - - -
100 400 500
51
Impaired Loans
Recorded Investment Unpaid Principal Allowance Average Investment
With allowance
Commercial loans 100 100 2 90
Commercial mortgages 50 50 4 50
Residential 10 10 1 15

With no allowance
Commercial loans 300 320 - 290
Commercial mortgages 450 450 - 440
Residential 90 100 - 80

Total
Commercial loans 400 420 2 380
Commercial mortgages 500 500 4 490
Residential 100 110 1 95
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Some Issues We Have Seen

• Negative provision for some categories
• Consistency between the buckets
• Negative, change, or size of unallocated
• gt90 days past due and still accruing
• Recorded investment versus unpaid principal
  balance
• Data gathering

53
Questions
54
Contact Information

• Baker Newman Noyes
• 280 Fore Street
• Portland, ME 04101-4177
• 207-879-2100
• Roger Poulin, CPA Nick Ireland, CPA Matt
  Prunier, CPA
• Principal Senior Manager Manager
• 207-791-7123 207-791-7521 207-791-7527
• rpoulin_at_bnncpa.com nireland_at_bnncpa.com
  mprunier_at_bnncpa.com
• Visit our website at www.bnncpa.com