leases: not just for the footnotes anymore -...

Leases: Not Just for the Footnotes Anymore

August 17, 2017

DHG Birmingham CPE Seminar 1

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August 17, 2017

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Lease Standard - Statistics

• 10 year project

• In 2014, $3.0 trillion in off-balance sheet lease commitments

• 47.1% of organizations concerned about their ability to implement


August 17, 2017


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Today’s Presenter: Brian Matney, Manager

Brian Matney is an audit manager in the Birmingham, Alabama office of DHG. Since joining the firm in 2010, Brian has provided assurance services in the form of financial statement audits, reviews, and compilations and has focused on serving the healthcare industry.

As a result of his full-time dedication to the healthcare industry, Brian serves organizations across the entire continuum of care. In addition to audits conducted under generally accepted auditing standards in the United States of America, Brian is experienced in audits under Governmental Auditing Standards.

Education• University of Alabama, Bachelor of Business

Administration, Accounting

• University of Alabama, Master of Accountancy

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Objective of the Session

Upon conclusion of the presentation you should be able to:

Explain the main differences between current lease accounting standard and the new standard

Identify working definitions of the key concepts necessary to apply the new lease accounting standard

Describe the lessee’s initial accounting for a lease

Develop an outline of a company-specific plan for implementing the new standard


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Significant Financial Statement Impact

New lease standard generally requires all leases to be capitalized and recognized on the balance sheet

+ Exception for short term leases

Implementing the new leasing standard may:

+ Change key ratios used for debt covenants

+ Affect bonus and share-based payment calculations

+ Alter dividend information

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Key Questions in Accounting for Leases

If not within scope of lease standard, must look to different ASC

WHY ASK

Required for initial accounting

Required for subsequent accounting

Account for non-lease components differently

Do I have a lease?

What is the term?

What is the discount rate?

Any non-lease components?


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GUIDANCE


Lease defined as “the right to control the use of an identified asset for a period of time in exchange for consideration.”

• Control:

- Right to economic benefits

- Right to direct use of asset

• Determining “right to direct use” may require judgment

• If supplier has substantive substitution rights, customer does not have control; therefore no lease.

Do I have a lease?

What is the term?



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• Term: Noncancelable period for which lessee has right to use asset plus periods covered by—

- Option to extend if lessees is reasonably certain to exercise the option

- Option to terminate if lessee is reasonably certain not to exercise option

- Renewals or extensions of lease at option of lessor

• Exception to the general rule to recognize all leases on the balance sheet for leases with terms of 12 months or less.

GUIDANCE

Do I have a lease?

What is the term?




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• Rate implicit in the lease is rate that causes the PV of the net investment in the lease to equal sum of:

- Fair value of asset minus related investment tax credit

- Capitalized initial direct costs incurred by lessor

• If rate can not be determined, use incremental borrowing rate

• Private companies may elect a policy for all leases to use risk-free discount rate

GUIDANCE

Do I have a lease?

What is the term?



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• Non-lease components accounted for separately

• Example: equipment lease contract also includes maintenance services

• Allocate contract consideration and initial direct costs to components based on relative standalone price of separate components

GUIDANCE

Do I have a lease?

What is the term?




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Polling Question

How prepared is your organization to implement the new lease standard?

a. Feeling good about it.

b. Thinking about it, but haven’t started it.

c. There’s a new lease standard?

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Finance vs. Operating Lease Classification

FINANCE LEASE

Substantially the same as a capital lease plus

• Lease of specialized asset for which no alternative use at end of lease term

All leases that do not meet criteria for finance lease

OPERATING LEASE


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Initial Measurement

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Initial Measurement

Very narrowly defined – excludes costs that would have been incurred regardless of whether the lease was obtained


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Finance Lease: Initial Accounting

Assets

aaaa $ xx,xxxx

ROU asset $ xx,xxxx

aaaa $ xx,xxxx

$ xxx,xxxx

Liabilities

bbbb $ xx,xxxx

Lease liability $ xx,xxxx

bbbb $ xx,xxxx

$ xxx,xxxx

Equity

cccc $ xx,xxxx

$ xxx,xxxx

• ROU Asset:

- Represents the lessee’s right to the use of the leased asset over the lease term

• Lease Liability:

- Represents the lessee’s contractual obligation to make lease payments over the lease term

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Finance Lease: Subsequent Accounting

Income Statement

Amortize ROU asset, straight line over useful life or lease term

Recognize interestexpense related to lease liability

Sales $ xx,xxxx

Cost of Sales

$ xx,xxxx

$ xxx,xxxx

Expenses

aaaa $ x,xxxx

Amortization $ x,xxxx

Interest $ x,xxxx

aaaa $ x,xxxx

$ xx,xxxx

Net Income $ xxx,xxxx


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Finance Lease: Subsequent Accounting

Cash Flow Statement

Interest expensereported as operating activity

Lease principal payments reported as financing activity

aaaa $ xx,xxxx

aaaa $ xx,xxxx

Interest expense $ xx,xxxx

Cash from operating activities $ xxx,xxxx

bbbb $ xx,xxxx

bbbb $ xx,xxxx

bbbb $ xx,xxxx

Cash from investing activities $ xxx,xxxx

Principal payments $ xx,xxxx

cccc $ xx,xxxx

Cash from financing activities $ xxx,xxxx

Change in cash $ xx,xxxx

Beginning cash $ xx,xxxx

Ending cash $ xx,xxxx

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Operating Lease: Initial Accounting

Assets

aaaa $ xx,xxxx

ROU asset $ xx,xxxx

aaaa $ xx,xxxx

$ xxx,xxxx

Liabilities

bbbb $ xx,xxxx


bbbb $ xx,xxxx

$ xxx,xxxx

Equity

cccc $ xx,xxxx

$ xxx,xxxx

• ROU Asset:

- Represents the lessee’s right to the use of the leased asset over the lease term

• Lease Liability:

- Represents the lessee’s contractual obligation to make lease payments over the lease term


August 17, 2017


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Operating Lease: Subsequent Accounting

Assets

aaaa $ xx,xxxx

ROU asset $ xx,xxxx

aaaa $ xx,xxxx

$ xxx,xxxx

Liabilities

bbbb $ xx,xxxx


bbbb $ xx,xxxx

$ xxx,xxxx

Equity

cccc $ xx,xxxx

$ xxx,xxxx

ROU asset

Asset equal to lease liability adjusted for

- Prepaid or accrued lease payments

- Remaining lease incentives

- Unamortized initial direct costs

- Asset impairment

Liability

Liability equal to PV of remaining lease payments at discount rate determined at inception

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Sales $ xx,xxxx

Cost of Sales $ xx,xxxx

$ xxx,xxxx

Expenses

aaaa $ x,xxxx

aaaa $ x,xxxx

Lease expense $ x,xxxx

aaaa $ x,xxxx

$ xx,xxxx

Net Income $ xxx,xxxx

Income Statement

Single lease expense, same as current GAAP –recognized straight-line over the lease term


August 17, 2017


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Cash Flow Statement

Lease expense reported as an operating activity

aaaa $ xx,xxxx

aaaa $ xx,xxxx

Lease expense $ xx,xxxx

Cash from operating activities $ xxx,xxxx

bbbb $ xx,xxxx

bbbb $ xx,xxxx

bbbb $ xx,xxxx

Cash from investing activities $ xxx,xxxx

cccc $ xx,xxxx

cccc $ xx,xxxx

Cash from financing activities $ xxx,xxxx

Change in cash $ xx,xxxx

Beginning cash $ xx,xxxx

Ending cash $ xx,xxxx

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Finance Lease: Walkthrough

Company leases equipment. Facts:

• Lease term: 60 months with option to extend for 24 months

• Lease payments: $2,500 per month during initial term; $2,750 during extension

• 10% increase during extension NOT considered significant financial incentive; therefore lease term is 60 months

• Initial direct costs: $7,000

• Discount rate: can not determine rate implicit in lease. Incremental borrowing rate 5.25 %

At inception:

• Company makes first month’s payment of $2,500 and incurs the $7,000 initial direct costs

• Lease liability measured as PV of remaining 59 payments at 5.25%. Equals $129,752

$ 139,252 $ 2,500$ 129,752

ROU Asset Lease Liability Cash

$ 7,000


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Finance Lease: Walkthrough

Subsequent accounting in year one

• Lease payments made during the year: $27,500

• ROU asset depreciated straight line over 5 year lease term. $139,252 ÷ 5 = $27,850

• Interest expense using effective interest method and 5.25% discount rate: $5,773

$ 27,850

$ 27,850

$ 139,252

$ 129,752$ 5,7735,773

ROU Asset

Lease LiabilityDepreciation Expense Interest Expense

Cash

$ 27,500

$ 27,500

$ 108,025

$ 111,402

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Operating Lease: Walkthrough

$ 129,752 $ 2,500$ 7,000

Company leases equipment. Facts:

• Lease term: 60 months with option to extend for 24

• Lease payments: $2,500 per monthduring initial term; $2,750 during extension

• 10% increase during extension NOT considered significant financial incentive; therefore lease term is 60 months

• Initial direct costs: $7,000

• Discount rate: can not determine rate implicit in lease. Incremental borrowing rate 5.25 %

At inception:

• Company makes first month’s paymentof $2,500 and incurs the $7,000 initial direct costs

• Lease liability measured as PV of remaining 59 payments at 5.25%. Equals $129,752

$ 139,252

ROU Asset Lease Liability Cash


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Operating Lease: Walkthrough

Subsequent accounting in year one

• Remaining lease payments made during the year: $27,500

• Lease expense: 1/5 of cash payments to be made during the lease term ($30,000) plus 1/5 of initial direct costs ($1,400) Total = $31,400

• Interest expense is same as finance lease: $5,773

• Remaining expense amount is credited against the ROU asset. $31,400 - $5,773 = $25,627

$ 139,252

$ 129,752

ROU Asset

Lease LiabilityLease Expense

$ 31,400

$ 25,627

5,773

Cash

$ 27,500

$ 27,500

$ 108,025

$ 113,625

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Lessor Accounting: What’s the Same

Lessor accounting largely unchanged from current

+ Most operating leases remain operating leases

+ Current lease classification is retained as well as accounting for each type

OPERATING LEASE CLASSIFICATION


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Lessor Accounting: What’s Changed

Classification changed to align with lessee guidance

Same classification criteria as finance lease in lessee model

Lessor to classify as direct financing if certain conditions are met

Operating leases

+ Incremental tests for leases involving real estate were removed

+ Leveraged leases no longer exist unless commenced prior to adoption

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Transition: Effective Dates

Effective dates for public companies

+ Fiscal years beginning after December 15, 2018, including interim periods—i.e., calendar 2019 starting in Q1

Effective dates for private companies

+ Fiscal years beginning after December 15, 2019—i.e., calendar 2020 year-end and calendar 2021 interim statements

Modified retrospective application with optional practical expedients

+ Must apply new standard as of beginning of the earliest periodpresented


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Transition: Practical Expedients

You may be able to elect “practical expedients” to ease burden of adoption

• Reassess whether expired or existing contracts are or contain leases

• Reassess lease classification for any expired or existing leases

• Reassess initial direct costs for existing leases

• May use hindsight in determining lease term

You do not need to

You may

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Possible Implementation Challenges

Systems

Operations

Financial Reporting

• Lessees with significant lease portfolio may need to evaluate current system and evaluate whether it can capture relevant data for new standard

• Compliance with debt covenants and other contracts

• May affect lease vs. buy decisions

• System change may require change to internal controls

• Increased use of management judgment

• Deferred income taxes may be affected

• New disclosure requirements

POSSIBLE CHALLENGES


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Implementation Next Steps

Inventory all existing lease contracts

- Aggregate similar leases to avoid redundant analyses

- Identify short term leases that will not be capitalized

Assess implementation challenges and options

- Existence of substantive substitution rights

- Choice of discount rate

- Determination of lease term

- “Practical expedients”

Estimate impact implementation will have on financial statements, key ratios and metrics

- Evaluate impact changes will have on other contracts, e.g., loan agreements, management compensation

- If necessary develop plan to mitigate impact on other contracts

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