7/30/2018. Health Care. A CHC-Focused Plan for the New Lease Accounting Standard

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1 Health Care A CHC-Focused Plan for the New Lease Accounting Standard July 31,

2 TO RECEIVE CPE CREDIT Individuals Participate in entire webinar Answer polls when they are provided Groups Group leader is the person who registered & logged on to the webinar Answer polls when they are provided Complete group attendance form Group leader sign bottom of form Submit group attendance form to within 24 hours of webinar If all eligibility requirements are met, each participant will be ed their CPE certificate within 15 business days of webinar S. Jansen Otterness, CPA Senior Manager 2

3 Topics & Agenda Background & Current GAAP New Guidance What to Do? Practical Expedients Implementation Matters Illustrative Example Odds & Ends Actionable Items Glossary & Abbreviations ASC Accounting Standards Codification ROU Right of use PV Present value FV Fair value EOM/BOM End of month/beginning of month 3

4 Background & Current GAAP Four criteria for lease analysis Transfer of ownership? Lease term > 75% of lease asset economic life? Bargain purchase option? Present value of minimum lease pmts. > 90% of asset fair value? Any yes response leads to capital lease treatment Background & Current GAAP Operating Leases Lease expense Recorded straight-line In general, no balance sheet impact Capital Leases Depreciation & interest expense Offsetting capital lease asset & long-term debt 4

5 Differences in Guidance Three broad categories Leases that are not classified as operating Existing leases classified as operating New leases classified as operating Why change!? What to Do, What to Do? Implementation Plans Leases executed prior to ASC 842 Inventory & evaluate existing leases Evaluate benefits of practical expedients Leases executed after ASC 842 Update Accounting Policy & Procedure Manual Document significant assumptions & practices Communicate with key stakeholders! 5

6 Practical Expedients Leases executed prior to ASC 842 Modified retrospective approach Avoids need to restate prior periods booked under the current guidance (ASC 840) Leases executed after ASC 842 Short-term lease policy election Document, Document, Document! Implementation Matters Existing Leases Maintain classification already assigned Determine the discount rate Implicit rate in the contract or Borrower s incremental borrowing rate or Risk-free rate (if lessee is not a public entity) Quantify the remaining cash flows Expected to exclude nonlease components (CAM) Should just be the remaining lease payments 6

7 Implementation Matters New Leases Six-Step Process Contract review Identify, separate & allocate contract components Evaluate lease options (extend, terminate, etc.) Determine lease classification (finance or operating) Quantify the lease liability & ROU asset Requires setting the discount rate Ongoing financial reporting Implementation Matters New Leases Review the Contract Is the contract subject to ASC 842 (timing)? Is the contract a lease or does it contain a lease? Is there an underlying asset? Does the agreement convey the right to control the asset? 7

8 Implementation Matters New Leases Identify, Separate & Allocate Contract Components Components transfer a good or service to the lessee Lease component: Cost to obtain right of use of asset Nonlease component: Cost to obtain a service, i.e., CAM Noncomponent cost: Pass-through cost, i.e., lessor s RE tax Policy election available to forgo this step Only applies to lease & nonlease components Costs that are not components, i.e., pass-through, still excluded Implementation Matters New Leases Evaluate Lessee Options Options to extend, terminate or otherwise alter contract How likely is lessee to exercise? Reasonably certain? What is evidence that option is reasonably certain to be exercised? 8

9 Implementation Matters New Leases Determine Lease Classification Operating or finance lease Now have five criteria for determining classification Transfer of ownership & bargain purchase option remain No more bright line tests to determine classification Does the lease represent the major part of the remaining economic life of the underlying leased asset? Does the PV of the lease payments represent substantially all of the remaining FV of the underlying leased asset? Is the leased asset so specialized it will have no alternative use? Implementation Matters New Leases Quantify the Lease Liability & Right-of-Use Asset Requires lessee to set & apply a discount rate Is there a rate implicit in the contract? If not, what is your incremental borrowing rate? Health centers also have the option to use a risk-free rate Public business entities cannot, but CHCs do not meet this definition 9

10 Implementation Matters New Leases Ongoing Financial Reporting No real change for finance (formerly capital) leases Operating leases will now show up on the balance sheet Key considerations from the change Recognize expense at EOM & increase lease liability Reduce lease liability at BOM by cash payment Materially the same regardless of payment terms ASC 842 Illustrative Example New operating lease subject to ASC year lease of an asset (facility) Annual payments of $50,000 (due in advance) Initial direct costs of $15,000 Five-year renewal option; annual payments of $55,000 Not reasonably assured to be exercised Implicit rate is not readily determinable in contract Incremental borrowing rate is 5.87% Common area maintenance is $5,000 per year 10

11 11

12 Illustrative Journal Entries Right-of-Use (ROU) Asset 407,017 Lease Liability 342,017 Cash 65, Lease Expense 51,500 Accum. Depr. ROU Asset 29,924 Accum. Amort. Initial Costs 1,500 Lease Liability 20,076 Illustrative Journal Entries Lease Liability 50,000 Cash 50, Lease Expense 51,500 Accum. Depr. & Amort. 33,180 Lease Liability 18, Lease Liability 50,000 Cash 50,000 12

13 Odds & Ends Effective Dates Early adoption for Public business entities NFP that has issued, or is a conduit bond obligor for, certain securities An employee benefit plan that files statements with SEC Odds & Ends Effective Dates In general, no worries on a CHC as a public business entity or being a benefit plan that files with the SEC Issuer or conduit bond obligor for certain securities Are the securities traded, listed or quoted on an exchange or an over-the-counter market? Think tax-exempt debt or a bond issuance Availability to be traded matters, not volume of trading Private placement letter may be sufficient to overcome this status 13

14 Odds & Ends Debt Covenant Implications Operating lease liabilities are not long-term debt This should alleviate covenant concerns like debt-to-equity ratios & restrictions on executing additional debt Operating lease liabilities will have a current & long-term component Communication continues to be key! Notify & collaborate with your banker ASAP! Odds & Ends Presentation Requirements Required for the earliest period presented Modified retrospective practical expedient applied Possible relief from current Exposure Draft Stay tuned May not need to quantify for both FY 2019 if you are a 12/31 entity Develop a plan early! 14

15 Odds & Ends Footnote Disclosures Terms & Conditions of Agreement Assumptions Made Discount rate Options to extend or terminate Variable payment considerations Reconciliation of Expense Reported Actionable Items Prepare for changes & updates to Accounting Policy & Procedure Manual Initiate communication with key stakeholders Inventory leases that will need to be measured upon adoption Apply the six-step model & start the valuation process Ask for help if you need it! 15

16 Questions? CONTINUING PROFESSIONAL EDUCATION (CPE) CREDIT BKD, LLP is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: The information contained in these slides is presented by professionals for your information only & is not to be considered as legal advice. Applying specific information to your situation requires careful consideration of facts & circumstances. Consult your BKD advisor or legal counsel before acting on any matters covered. 16

17 CPE CREDIT CPE credit may be awarded upon verification of participant attendance For questions, concerns or comments regarding CPE credit, please the BKD Learning & Development Department at Thank You! S. Jansen Otterness

18 BKD Thoughtware Webinars, seminars & articles Many are CPE-eligible Thoughtful & technical content designed specifically for CHCs bkd.com/chc 18

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