webinar: private companies: transitioning to the new lease … · 2020-02-12 · strictly private...

Private Companies: Transitioning to the New Lease Accounting Standard (ASC 842)

Implementing the New Lease StandardFebruary 11, 2020

Strictly Private and Confidential


Overview of the new lease standardOverviewASC 842 requires companies to make significant changes to the reporting of their operating lease population. Under the newstandard, operating leases will move from footnote disclosures directly to the balance sheet. As a result, operating leaseobligations will face increased auditor scrutiny, pushing companies to focus on ensuring accuracy and completeness of theirreporting and leading to greater comparability of financial statements.

Summary of the modelASC 842 was implemented to address a major information gap in ASC 840; off-balance sheet operating leases.

ASC 842 effective datesPublic companies: effective for reporting periods beginning after December 15, 2018 (Q1 2019).Private companies: effective for reporting periods beginning after December 15, 2020 (Q1 2021).

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StandardPublic Business Entities (PBEs) Private & All

OthersSEC Filers All Other PBEs

ASC 842 - Leases January 2019 January 2019January 2020

January 2021


Identifying a leaseDefinition of a leaseA lease is a contract, or part of a contract, that conveys the right to control the use of identified asset for a period of time in exchange for consideration.

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For a contract to be, or contain a lease, it must:

Identify a physically distinct property, plant or equipment.

Convey the right to control the use said property, plant or equipment over a

period of time.and

Right to obtain substantially all of the

economic benefits from the asset use.

Right to direct the use of the asset over the lease

term.and

For a contract to be, or contain a lease, it must:

Identify a physically distinct property, plant or equipment.

Convey the right to control the use said property, plant or equipment over a

period of time.


Lease classification

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Finance lease classification criteria:

The lease transfers ownership of the underlying asset to the lessee bythe end of the lease term.

The lease grants the lessee an option to purchase the underlying assetthat the lessee is reasonably certain to exercise.

The lease term is for the major part of the remaining economic life of theunderlying asset.*

The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.

The present value of the sum of the lease payments and any residualvalue guaranteed by the lessee exceeds substantially all of the fair value of

the underlying asset.**

* 75% or more of the remaining economic life of the underlying asset is a major part of its remaining economic life** 90% or more of the fair value of the underlying asset amounts to substantially all of its fair value

or

or

or

or


Lease term

Reassessing the lease term and purchase optionsExamples of significant events or significant changes in circumstances that a lessee should consider: Construction of significant leasehold improvements with a significant economic value and economic life beyond a renewal

option. Significant modifications or customizations to the underlying asset. Business decision that are directly relevant to the lessee’s ability to exercise or not to exercise an option. Subleasing the underlying asset for a period beyond the exercise date of the option.

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The lease term includes the noncancelable period specified in the

lease agreement, plus

Termination options that are reasonably certain not to be exercised

by a lessee

Renewal options that are reasonably certain to be exercised by a lessee

Options to extend (or terminate) that are controlled by the lessor


Lease modifications

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Modification grants an additional Right

of Use (“ROU”)

Modification extends or reduces

lease term

Modification only changes

consideration

Modification fully or partially terminates

lease

At stand-alone price

Not at stand-alone price

Reassess classification and use updated lease payments and discount rate to remeasure the ROU asset and lease

liability

Recognize the lease modification as a new lease, separate from

the original lease

Reassess classification, remeasure the lease liability,

decrease a proportionate amount of the ROU asset, and recognize any difference as a

gain/loss


Lease payments

Amounts included in lease payments

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Variable payments ++Fixed lease payments

Residual value guarantees + Payments for

penalties

Includes payments that depend on an

index or a rate (does not include

payments based on usage or

performance)

Payments specified in the lease

agreement, less any lease incentives

Amount probable that will be owed under the residual value guarantee at

the end of the lease term

If the lessee exercises the

option to terminate the

lease

Lease payments do not include: Variable lease payments based on usage or performance. Any guarantee of the lessor’s debt by the lessee. Amounts allocated to non-lease components.


Presentation requirements

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Lessee model

Balance sheet Income statement Cash flow statement

Finance leaseROU asset Amortization expense Principal (Financing)

Lease liability Interest expense Interest (Operating)

Operating leaseROU asset

Lease expense (single line item on SL basis) Lease payments (Operating)

Lease liability

Disclosure objectiveEnable financial statement users to assess the amount, timing and uncertainty of cash flows arising from leases. Companies must apply the new model for the earliest year presented in the financial statements.


Lease discount rate

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Lessee1. Rate Implicit in the Lease (IRR)

- Difficult for lessees to assess

2. Incremental Borrowing Rate (IBR)

- Company specific rate addressing company and economic environment risks

3. Risk-Free Rate (Private Company Practical Expedient)

- Treasury rates

Lessor1. Rate Implicit in the Lease (IRR)

- Internal rate of return of a lease

ReassessmentFrequency is not prescribed by FASB or IASB. Commonly the rate is refreshed on a quarterly, semi-annually or annually. The determination of the frequency should be based on management’s assessment of the following factors:

1. Materiality of the lease balances to the balance sheet.2. Changes in the company’s credit rating and volatility in the economic environment.


ASC 842 vs. IFRS 16

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Key differences between ASC 842 and IFRS 16

Lease classificationASC 842 uses the dual classification model where leases are determined to be either finance or operating leases. IFRS 16 removed the operating lease classification and adopted a single lease classification approach.

Practical expedients and exemptionsASC 842 provides an exemption for short-term leases (12 months or less) where lessees can avoid the recognition of a ROU asset and corresponding lease liability on the balance sheet. IFRS 16 provides the same short-term lease exemption, but provides an additional exemption for a low-value leases ($5,000 or less).

Financial reportingUnder ASC 842, with all else being equal, companies will report a higher net income in the early periods of adoption, but a lower EBIT and EBITDA.

ASC 842 IFRS 16

Finance leases X X

Operating leases X

Short-term lease exemption X X

Low-value asset lease exemption X

Discount rate practical expedient X

Full-retrospective approach X


Transition to ASC 842 and IFRS 16

Early adoptionAll companies, public and private, are permitted to implement the new lease accounting standard prior to their respective effective dates.

Transition methods

GAAP1. Modified Retrospective Approach

IFRS1. Modified Retrospective Approach2. Full Retrospective Approach

Practical expedients

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Practical expedient package Hindsight Combine lease and non-Lease components

Short-term leases Private company lease discount rate (GAAP)

Low Asset Value Leases (IFRS)


Implementation

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Data housing alternatives

1. Lease population size2. Reporting requirements3. Materiality4. Complexity of leases

Excel

Challenges

System

Systemimplementation

Legacy accountingStaffingTimingTraining


Tax and other considerations

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Tax consideration

No impact to lease treatment for federal income tax purposes, BUT changes to accounting policies, lease terms, and processes may impact several areas within the tax function including:

1. Deferred tax accounting,2. Foreign tax processes, and3. Transfer pricing.

FX Rates and CPI index

Considerations for leases denominated in a foreign currency and with CPI index based payment escalations:1. Lease payments impacted by foreign currency and inflation index increases are pegged at the inception of the lease or

at transition, with fluctuations expensed as incurred. 2. Day-two accounting for FX leases, the ROU asset is carried at historical rates and lease liability is carried at current

rates.

ControlsConsider internal control over financial reporting, particularly as it relates to Emerging Growth Companies that need to comply with Section 404 of the Sarbanes-Oxley Act.


Key takeaways

Start early. Appoint individual or steering committee. Determine the need for a software. Elect practical expedients. Develop standard operating procedures.

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Contact Info

Jesus Socorro, CPAManaging Principal, Risk & Transaction Advisory

[email protected]

Alex Montorro, CPASenior Manager

[email protected]

Dimas Correa, CPA, CFASupervisor

[email protected]

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webinar: private companies: transitioning to the new lease … · 2020-02-12 · strictly private...

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