2018 Accounting & Auditing Update P R E S E N T E D B Y : D A N I E L L E Z I M M E R M A N & A N D R E A S A R T I N
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1 2018 Accounting & Auditing Update P R E S E N T E D B Y : D A N I E L L E Z I M M E R M A N & A N D R E A S A R T I N
2 AGENDA Leases FASB & GASB Revenue Recognition FASB 2
3 FASB ASU , Leases (Topic 842) 4
4 FASB DEFINITION OF LEASE New Guidance An arrangement contains a lease only when such arrangement conveys the right to control the use of an identified asset. Existing GAAP An arrangement can contain a lease even without control of the use of the asset if the customer takes substantially all of the output over the term of the arrangement. For contracts that include substantial services, evaluating whether the arrangement meets the definition of lease could require significant judgement. Accordingly, the revised definition of lease could result on some arrangements receiving different accounting treatment compared to current guidance. 5
5 LEASE CLASSIFICATION New Guidance Elimination of bright lines & addition of one additional criterion: If the underlying asset is of such a specialized nature that it is expected to have no alternative to the lessor, the lease is a finance lease. The determination of whether or not a contract is a lease or contains a lease is done at lease inception. Lease classification, recognition & measurement are determined at the lease commencement date. Existing GAAP Bright-line test: A lease is a capital lease if the lease is for a major portion of the asset s life (75%) or payments represent substantially all of the asset s value (90%). Assumptions relevant to classification & measurement are determined at lease inception. Recognition of rent expense or capital lease assets & liabilities begin at the lease commencement date. The lack of explicit bright lines will increase the level of judgment required when classifying a lease particularly for certain highly structured transactions. However, the basis for conclusions acknowledges that one reasonable approach would be to use the bright-line tests. Transition reliefs permit an entity to avoid reassessment of lease classification for existing leases at the day of adoption & avoid reassessment of initial direct costs previously capitalized (some of which may no longer qualify for capitalization). 6
6 LEASE CLASSIFICATION Financing lease criterion: Transfer of ownership by the end of the lease term Option to purchase the underlying asset (reasonably assured to exercise) Term is for a major part of the remaining economic life of the asset Present value of the sum of lease payments >/= substantially all of the FV of the 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 7
7 COMPARISON OF LESSEE MODELS Balance Sheet Finance Lease Operating Lease Right of Use (ROU) Asset * Right of Use (ROU) Asset ** Lease Liability Lease Liability *Periodically reduced by straight-line amortization ** Periodically reduced by the difference between straight-line lease expense & interest cost on lease liability, i.e., plug figure 8
8 EFFECT ON BALANCE SHEET Operating Lease Example: Lessee signs a lease for a building on January 1, Year 1 Lease period is 10 years Annual payment is $1,627,049 Lessee s incremental borrowing rate is 10% PV of lease payments (computed) is $10,000,000 Economic life is 20 years Estimated FV is $20,000,000 Building transfers back to the lessor at the end of the term 1/1/Y1 Right-of-Use Asset $10,000,000 Lease Liability $10,000,000 9
9 EFFECT ON BALANCE SHEET Total current assets Other 25,000 Current GAAP ASU $ 33,000 25,000 Lease Assets (ROU Asset) 2,200 2,200 10,000 Property, plant & equipment Total noncurrent assets Total Assets Other liabilities 67,000 55,000 94, ,200 67,000 55,000 Lease Liabilities 1,900 1,900 10,000 Borrowings Total liabilities Equity 27,000 83,900 43,300 27,000 $ 33, , ,200 93,900 43,300 Total Liabilities & Equity $ 127,200 $ 137,200 Recognizing operating leases on the balance sheet will have minimal, if any, effect on the income statement or statement of cash flows compared to current GAAP. 10
10 COMPARISON OF LESSEE MODELS Income Statement Finance Lease Interest Expense (on lease liability) Amortization Expense (on ROU asset) Operating Lease Lease/Rent Expense (straight-line) 11
11 EFFECT ON INCOME STATEMENT Operating Lease Example: Lessee signs a lease for a building on January 1, Year 1 Lease period is 10 years Annual payment is $1,627,049 due on December 31, Year 1 Lessee s incremental borrowing rate is 10% PV of lease payments (computed) is $10,000,000 Economic life is 20 years Estimated FV is $20,000,000 Building transfers back to the lessor at the end of the term 12/31/Y1 Lease Expense $1,627,049 Lease Liability $1,000,000 Right-of-Use Asset $ 627,049 12/31/Y1 Lease Liability $1,627,049 Cash $1,627,049 12
12 EFFECT ON INCOME STATEMENT Operating Lease Finance Lease Revenue & other income Cost of sales $ 175,000 (150,000) $ 175,000 (150,000) Gross Profit 25,000 25,000 Operating costs (includes operating lease expense) (13,300) (11,700) EBITDA 11,700 13,300 Depreciation & amortization (includes ROU amortization - finance lease) (6,833) Operating Profit 11,700 6,467 Net finance costs (includes interest expense finance lease) (1,300) (2,940) Profit before tax 10,400 3,527 Income tax (1,300) (1,146) Profit for year $ 9,100 $ 2,381 Leverage Ratios Total commitments (borrowings plus lease liabilities) to EBITDA Higher Lower 13
13 COMPARISON OF LESSEE MODELS Cash Flow Statement Finance Lease Cash paid for principal payments as financing activities; interest & variable lease payments as operating activities Operating Lease Cash paid for lease payments as operating activities 14
14 NEW VS. EXISTING LEASE GUIDANCE Lease vs. Nonlease Components Lessors & Lessees New Guidance Existing GAAP Components include only those items or activities that transfer a good or service to the lessee. Property taxes & insurance are not considered separate components of a contract because they do not represent a service provided by the lessor to the lessee. Therefore, they are part of lease payments. Entity must account for the right to use land & other assets (e.g., buildings) separately, unless effect of doing so would be insignificant to overall accounting for transaction. Property taxes & insurance are subject to lease accounting guidance but are considered executory costs & are expensed rather than included in minimum lease payments. Land is separately classified when the fair value of the land is 25% or more of the combined fair value of the land & building. Entities may want to consider structuring property taxes & insurance as variable lease payments instead of including them in fixed payments. Examples of nonlease service components include maintenance, cleaning & repair services. 15
15 EFFECTIVE DATE PUBLIC BUSINESS ENTITIES January 1, 2017 Calendar Year 2018 Account for leases under existing GAAP through end of period immediately prior to transition; account for leases under new standards as of beginning of earliest comparative period. Companies that adopt set of transition reliefs will not need to reassess lease classification. Thus, dual reporting throughout transition period will generally not be required. Transition Period Calendar Year 2019, Including Interim Periods Effective Date Account for leases under new standard for all periods presented, e.g., present comparative balance sheet for years 2018 & 2019, present comparative income statement for years 2017, 2018 & Effective dates apply to public business entities; NFPs that have issued, or are a conduit bond obligor for securities traded, listed or quoted on exchange or OTC market; & EBPs that files financial statements with the SEC. 17
16 EFFECTIVE DATE ALL OTHER ENTITIES Calendar Year 2017 Calendar Year 2018 Account for leases under existing GAAP through end of period immediately prior to transition. Calendar Year 2019 Account for leases under new standards as of beginning of the earliest comparative period. Applicable if lessee presents two years comparative financial statements. Transition Period Calendar Year 2020 Effective Date Account for leases under new standard for all periods presented. Companies that adopt set of transition reliefs will not need to reassess lease classification. Thus, dual reporting throughout transition period will generally not be required. 18
17 TRANSITION PRACTICAL EXPEDIENTS Entity can choose to elect a set of three specifically defined practical expedients all three or none must be used Lessee (or lessor) need not reassess Whether any expired or existing contracts are or contain leases Lease classification for any expired or existing lease Initial direct costs for any existing lease May also select another separate, practical expedient to use hindsight in evaluating lessee options to extend or terminate lease or to purchase underlying asset 19
18 KEY TAKEAWAYS All leases (>12 months) recorded on balance sheet Expense recognition substantially unchanged Criteria to classify leases as operating or financing similar to current criteria except no more bright line thresholds 20
19 GASB Statement No. 87, Leases 21
20 GASB DEFINITION OF A LEASE New Guidance A contract that conveys control of the right to use another entity s nonfinancial asset (the underlying asset) as specified in the contract for a period of time in an exchange or exchange-like transaction. Existing GAAP An agreement can contain a lease even without control of the use of the asset if the customer takes substantially all of the present service capacity from the underlying asset s use. GASB Statement No. 87 replaces the term agreement under current guidance with the term contract to require that a lease whether written or verbal is legally enforceable. 22
21 LEASE CLASSIFICATION For all leases, except short-term leases & contracts that transfer ownership of the underlying asset to the lessee & do not contain termination options, the lessee will record a lease liability No distinction of lease types (differs from FASB) 23
22 LEASE RECOGNITION Balance Sheet Lease Liability Measured at the present value of future lease payments expected to be made during the lease term Intangible ROU Asset Measurement based on the lease liability s initial measurement, adjusted for certain prepayments, incentives & direct costs 24
23 LEASE RECOGNITION Income Statement Lease Liability Recognize interest expense related to discount amortization Intangible ROU Asset Recognize amortization expense representing the decrease in useful life of the right to use the underlying asset 25
24 DISCLOSURE REQUIREMENTS Required to disclose the expense recognized in the period for variable lease payments or terminations not previously included in the lease liability s measurement This is in addition to existing disclosures about leasing arrangements, including leased assets & accumulated amortization & principal & interest requirements to maturity 26
25 LESSOR MEASUREMENT Lease Receivable Measured at the present value of future lease payments expected to be received during the lease term, reduced by any provision for uncollectible amounts Deferred Inflow of Resources Corresponding to the lease receivable s initial measurement, plus lease payments received from the lessee at or before lease commencement that relate to future periods Under Statement 87, the underlying asset is NOT derecognized. 27
26 LESSOR MEASUREMENT Revenue recognized over the lease term, with interest revenue & other lease-related revenue separately reported Underlying asset should continue to be accounted for in accordance with other applicable guidance, including depreciation or impairment 28
27 LESSOR DISCLOSURES Similar to lessees, more disclosures required about the effect on current resources arising from leasing activities Disclose lease revenue & interest revenue (if not determinable based on what is on the face of the financial statements) & resource inflows from variable lease payments & other payments not included in the lease receivable Previous disclosure requirements still remain on description of leasing arrangements 29
28 LEASE INCENTIVES Received at or Before Inception Directly reduce the lessee s recorded initial lease asset amount Received After Inception Accounted for by both the lessee & lessor as reductions of lease payments in the year the payments will be provided 30
29 EFFECTIVE DATE & TRANSITION GUIDANCE Effective for reporting periods beginning after December 15, 2019 Provisions should be retroactively applied by restating prior financial statements for all periods presented Reasonable efforts should be employed before determining restatement is not practical inconvenient is not a baseline for not restating Based on facts & circumstances that existed at the beginning of the implementation period or the beginning of the earliest period restated 31
30 WHAT TO DO NOW? Review standard and related resources Inventory all lease contracts & determine whether other contracts contain leases Determine appropriate level at which to aggregate or disaggregate disclosures Collaborate with others in industry 32 Consider business implications, educate audit committees, boards and any other key stakeholders
31 FASB ASU No , Revenue from Contracts with Customers (Topic 606) 33
32 CORE PRINCIPLE 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. 34
33 SCOPE All entities that enter into contracts with customers Public, private, not-for-profit Regardless of industry All contracts with customers except: Lease contracts Insurance contracts Financial instruments Guarantees Nonmonetary exchanges between entities in the same business to facilitate sales to customers Excludes: Contributions Collaborative agreements 35
34 EFFECTIVE DATES Entity Type Public entities, including conduit debt obligors Nonpublic entities Effective Date Fiscal years beginning after December 15, 2017, including interim periods therein Fiscal years beginning after December 15, 2018, including interim periods therein 36
35 TRANSITION APPROACHES 37 Transition Approach Full retrospective Retrospective (using one more practical expedient) Cumulative effect at date of adoption Date of Cumulative Adjustment Restate for all contracts Restate for all contracts except those covered by practical expedients No contracts restated; reported based on legacy guidance Apply to all contracts Apply to all contracts Apply to all contracts January 1, 2017 July 1, 2017 January 1, 2017 July 1, 2017 January 1, 2017 July 1, 2017
36 PRACTICAL EXPEDIENTS Guidance specifies the accounting is for an individual contract with a customer, however, as a practical expedient, an entity may apply guidance to a portfolio of contracts if it does not differ materially from applying the guidance on an individual basis 38
37 REVENUE RECOGNITION PROCESS Identify Contract with a Customer Identify Performance Obligations Determine the Transaction Price Allocate the Transaction Price 39 Recognize Revenue When (or As) a Performance Obligation is Satisfied
38 STEP 1: IDENTIFY CONTRACTS WITH A CUSTOMER Must create enforceable rights and obligations 1. Approval and commitment of the parties (in writing, orally, or in accordance with other customary business practices) 2. Identification of the rights of the parties 3. Identification of the payment terms 4. The contract has commercial substance 5. It is probable that the entity will collect the money it is entitled to for providing the service 40
39 EXAMPLE: ELECTIVE VS. EMERGENT Scenario # 1: Elective procedure a signed patient consent form Scenario #2: Emergent patient patient enters the hospital through the emergency room unconscious and upon arrival, services are immediately provided 41
40 COLLECTABILITY Collectability will be explicit threshold that must be assessed before applying revenue recognition model to contract Entity must evaluate credit risk and conclude probable amount to be collected Assessment based on both customer s ability and intent to pay amounts due Difficult for health care entities to assess No such thing as cash basis in the revenue recognition model 42
41 STEP 2: IDENTIFYING PERFORMANCE OBLIGATIONS Performance obligation promise in a contract to transfer a good or service to customer Identify all distinct performance obligations in the contract Capable of being distinct Distinct within the context of the contract 43
42 EXAMPLE: MULTIPLE PERFORMANCE OBLIGATIONS Scenario # 3: Assisted living facility resident Contract separately identifies room and board, cable and hair cuts Standard charges per month: Room and board: $6,000 Cable: $30 Hair cuts: $15 Allowable under insurance contract - $2,000 per month for room and board 44
43 STEP 3: DETERMINING THE TRANSACTION PRICE Transaction price amount of consideration for goods or services provided to the customer Variable consideration Constraining estimates of variable consideration Existence of significant financing component Noncash consideration Consideration payable to the customer Consideration is variable if explicitly stated, or if Customer has valid expectation arising from entity s customary business practices accept amount less than stated contract Other facts or circumstances indicate entities intention to offer price concession 45
44 ESTIMATE OF VARIABLE CONSIDERATION Explicitly stated in contract, OR Estimated based on the following methods: Expected Value Sum of probability-weighted amounts in a range of possible outcomes Most Likely Amount The single most likely amount in a range of possible outcomes Most predictive when the transaction has a large number of possible outcomes Most predictive when the transaction has two possible outcomes Required to evaluate whether to constrain amounts of variable consideration included in the transaction price Objective of the constraint include variable consideration in the transaction price only to the extent it is probable a significant revenue reversal will not occur Estimates must be updated each reporting period 46
45 PORTFOLIO APPROACH Entities can apply the standard or aspects of it to a portfolio of contracts or performance obligations with similar characteristics (i.e. portfolio approach) Entities must reasonably expect that the financial statements effect of using the portfolio approach will not differ materially from applying the standard contract-by-contract basis Key considerations: How to apply a portfolio approach How to establish portfolios How to determine effect would not differ materially 47
46 PORTFOLIO APPROACH Portfolio approach may be applied to all aspects of the model or only to certain steps If establishing portfolio, an entity will need to use judgment to determine the size, composition, and number of portfolios Health care entities may consider segregating by payer class, type of service and other categories An entity also will need to consider materiality and documentation requirements 48
47 SELF-PAY REVENUE Existing Guidance Gross charges, net of self-pay discounts recorded as contractual adjustments Bad debt expense recorded and presented separately as a reduction to net patient service revenue if an entity does not assess collectability New Guidance Record revenue at amount entity expects to be entitled Bad debt expenses presented as an operating expense. Use of judgement in determining what constitutes bad debt versus implicit price concession. No change in charity care guidance 49
48 ACCOUNTING FOR SUBSEQUENT CHANGES If changes occur, evaluate whether a change in implicit price concession or a credit loss If information received indicates it is a credit loss (patient loss job or declared bankruptcy), the difference between expected cash receipt and revenue originally recorded is bad debt expense If no information is received for credit loss, the difference between expected cash receipt and revenue originally recorded is a change in revenue 50
49 EXAMPLE: TRANSACTION PRICE Scenario # 4: Emergency room patient uninsured Due to patient s condition, medical services provided upon arrival Standard ED charges - $10,000 Patient does not meet charity care policy Estimated collectability at the time of service - $1,000 How much revenue would you expect to record? 51
50 STEP 4: ALLOCATE THE TRANSACTION PRICE If multiple performance obligations, transaction price must be allocated based on their standalone selling price Allocation of any discount should also be proportionate Two exceptions: Terms of variable payment are specific to one performance obligations Allocate discount to only those goods or services to which it relates 52
51 EXAMPLE: ALLOCATION OF TRANSACTION PRICE Scenario # 5: Broken bone and corrective surgery discrete surgery Standard charges Broken bone: $2,000 Corrective surgery: $18,000 Uninsured patient Estimated collectability at the time of service - $2,000 What is the transaction price allocation? 53
52 STEP 5: RECOGNIZE REVENUE WHEN (OR AS) A PERFORMANCE OBLIGATION IS SATISFIED Revenue recognized by satisfying performance obligation when control over good or service is transferred to customer 54
53 WHAT IF CONSIDERATION IS RECEIVED BEFORE STEP 1 (CONTRACT) MET? Consideration received recorded as liability until conditions below met. Continually reassess the arrangement if step 1 criteria are met, begin applying revenue model, otherwise: Recognize revenue when either of the following events occur: 1. No remaining obligation and substantially all consideration is collected and is non-refundable or 2. The contract is terminated and consideration is non-refundable 55
54 INCOME STATEMENT NOW AND THEN Before: After: 56
55 DISCLOSURES Per ASC Revenue from contracts with customers, including the disaggregation of revenue in appropriate categories Contract balances, including the opening and closing balances of receivables, contract assets and contract liabilities Revenue recognized in the reporting period that was included in the contract liability at the beginning of the period Revenue recognized in the reporting period that performance obligations satisfied Significant judgments and changes in judgments, made in applying the requirements to those contracts 57
56 WHAT TO DO NOW? Review standard and related resources Identify a champion or task force to implement Identify revenue streams and document process, analysis and conclusion for each Collaborate with others in industry Determine changes needed and educate audit committees and boards 58
57 HELPFUL RESOURCES FASB ASU No AICPA A&A Guide Revenue Recognition AICPA website /revenuerecognition/pages/rrtf-healthcare.aspx BKD website BKD Thoughtware BKD White Paper Comprehensive-Review-for-Health-Care-Entities.pdf 59
58 Thank You! Danielle Zimmerman, Director Andrea Sartin, Manager
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