Lease Accounting under ASC 842

Transcription

1 Lease Accounting under ASC 842 Neil MacDonald CPA CMA PMP Solutions Consultant Binary Stream Software Inc

2 Introduction Neil MacDonald CPA, CMA, PMP 30+ years progressive Business, Project and IT Management, formal management and financial training, technical and industry certifications Project management and technical leadership in the delivery of IT and ERP implementations Resolution and consulting skills in applying best practices and efficiency initiatives Career History: Solutions Consultant 2011 Present Dynamics GP Consultant Mgr. IT and Process Improvements

3 Disclaimer Lease Accounting under ASC 842 ASC 842 is new. It is extensive. The guidance from FASB runs close to 200 pages long, detailed pages This webinar will only cover the high level points to get you started on ASC 842. It is in no way intended to be comprehensive, and due to the ever changing updates from FASB, is not meant to be a conclusive coverage of ASC 842 While I am a CPA CMA (Chartered Professional Accountant / Certified Management Accountant), I am not a life-long expert in leasing I am also not YOUR CPA It is your responsibility to learn as much about ASC 842 as you can, from various resources, accounting white papers and articles, as well as the relevant IASB or IFRS topics and discuss these with your own CPAs and auditors to ensure you are compliant 3

4 Session agenda Lease Accounting under ASC 842 Why are we here? Goals / objectives of this webinar What is ASC 842? Identifying and classifying your leases Lessee accounting creating Right of Use assets / lease liabilities Lease vs Non-Lease components & direct vs indirect costs Steps to prepare for ASC 842 adoption How can I be ASC 842 compliant with my leases in Dynamics GP? Q&A but feel free to ask questions any time! 4

5 Goals / Objectives Lease Accounting under ASC 842 Understanding ASC 842 Allow you to recognize if this applies to you, whether lessee or lessor Help you plan for ASC 842 adoption what do you need to know and consider? Understand what some of the industry experts and accounting firms are recommending Discuss how to handle ASC 842 in Dynamics GP 5

6 Challenges ASC 842 ASC 842 is new and comprehensive; I don t really understand it! I don t have time to read ASC 842 I have lots of leases Implementation time is too close! My ERP may not handle ASC 842 automatically

7 ASC 842 Leases aka ASU , IFRS 16 Acknowledgement is given to the following resources used to compile this presentation: New Developments Summary FASB issues new lease accounting standard Grant Thornton 10 Minutes on the new US lease standard PwC Executive Accounting Update Lessees KPMG Executive Accounting Update Lessors - KPMG Leases (Topic 842) - FASB 7

8 What is ASC 842? Updated FASB accounting standard; replaces ASC 840 IFRS updated as well (IFRS 16), but not identical Changes lease accounting for both lessors and lessees Lessor changes are minimal mainly lease classification Lessee changes are significant, so we will focus on those Key points: Lessors focus on control of the asset to determine lease type; most accounting remains similar to today s standard Lessees will show all leases longer than 12 months on the balance sheet, with a right of use asset and a corresponding liability / investment 8

9 Do I need to care about ASC 842? Who is affected by ASC 842? Topic 842 affects any entity that enters into a lease (as that term is defined in this update), with some specified scope exemptions. If your company leases as the lessor or the lessee - real property, land, computers, copiers, vehicles, trade marks etc ASC 842 applies to you! 9

10 ASC 842 timing When does ASC 842 go into effect? For public companies and some NFPs: as of fiscal periods beginning after Dec 15, 2018; option to adopt 1 year early Applies to NFPs that have issued, or are conduit bond obligators for, securities that are traded, listed or quoted on an exchange or OTC markets For private companies and all other NFPs As of fiscal periods beginning after Dec 15, 2019 Option to adopt two years early Early adoption may make sense for lessors because the changes are fewer, and while implementing ASC

11 Transition Modified Retrospective Transition Requires adjusting the accounting for any leases existing at the beginning of the earliest comparative period Typically means 2 years of retrospective adjustment (for publicly traded companies, 2019 implementation requires 2018 and 2017 comparative financials) Leases that expire before the implementation date will not require adjusting For some firms, due to the extent of their leasing activities, this might be very difficult and time consuming Many examples provided to guide both lessors and lessees: See through 254 Section has several pages covering practical expedients with illustrations 11

12 Transition BREAKING NEWS! Cumulative Update ASU , Leases (ASC 842) Targeted Improvements - Released August 2018 Allows users to apply ASC 842 at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption Entities that elect this method should report comparative periods in accordance with ASC 840 Lessors may also elect a practical expedient allowing them to not separate lease and non-lease components, by asset class. There are limitations to this election so read ASU to ensure it applies to you. 12

13 Identify Your Leases

14 Identify your leases Section contains a flowchart to help determine whether a contract is or contains a lease. Note that the flow chart does not include all the guidance on identifying a lease in this subtopic and is not intended as a substitute for the guidance on identifying a lease in this subtopic. 14

15 Lease, or no lease? A coffee company (customer) enters into a contract with an airport operator (supplier) to use space for it s kiosk for a three year period. Contract specifies size of space, but not location. In fact, the supplier can dictate that the kiosk be moved at its discretion. There are minimal costs to supplier to move the customer. Customer owns the kiosk, and there are many areas in the airport where the customer might be located and/or relocated. Lease or no lease? 15

16 Lease, or no lease? A utility company (customer) enters into a contract to purchase all the electricity produced by supplier s solar farm for 20 years. The solar farm is listed in the contract and the supplier cannot substitute it; the solar power cannot come from another facility. Customer designed the solar farm, hiring experts to determine the best location and engineer the equipment. Supplier built to customer s specs and must maintain the farm. Supplier receives tax credits relating to construction and ownership, customer receives renewable energy credits that accrue from use of solar farm. Lease or no lease? 16

17 Lease, or no lease? A utility company (customer) enters into a contract to purchase all the electricity produced by supplier s explicitly stated plant for 3 years. The supplier owns, maintains and operates the plant and cannot substitute it. The contract sets out the quantity and timing of the power produced. Supplier designed the power plant and built it prior to entering into contract with customer. Lease or no lease? 17

18 Lease, or no lease? Customer enters into a contract with a telecom company (supplier) for network services for 2 years. Contract requires supplier to meet a specified quality level. Supplier installs, configures and operates servers on customer s premises. Supplier determines speed and quality of data transport. Supplier can reconfigure the servers/network to meet service level. Lease or no lease? No lease! ( through 126) Contract is a service contract, with no identified asset, wherein the supplier uses equipment to meet a service level. Customer does not control the servers; level of service is specified and cannot be changed without a new/modified contract. Even though customer creates the traffic, that does not change the configuration of the network, and does not affect how and for what purpose the servers are used. Supplier makes decisions over how servers are configured and used. 18

19 Lease, or no lease? Customer enters into a contract with a telecom company (supplier) for use of a specific server for 3 years. Supplier installs, configures and maintains server on customer s premises. Supplier substitutes server only in the event of a malfunction. Customer decides what data is stored on the server and how it fits into its server farm; customer can change these decisions at any time during the contract. Lease or no lease? Lease! ( through 130) There is an identified asset, which customer has the right to use and control for three years. Customer has the right to change the use of the server; supplier does not. Customer has the right to obtain all economic benefits from use of the server; customer also has exclusive use of the server. Customer has the right to direct the use of the server and change that at any time, without consulting the supplier. 19

20 Identify your leases (continued) Lease classifications Lessees will need to distinguish between operating and financing (formerly capital) leases Lessors will need to distinguish between sales-type, direct financing and operating leases Since virtually all leases will now appear on the balance sheet, these lease types affect how lessees and lessors recognize expense / revenue on the P&L 20

21 Identify your leases (continued) Lease classifications Under ASC 842, a lease is a financing lease for a lessee, and a sales-type lease for a lessor if the lessee obtains effective control of the asset. What determines effective control? If any of the following are met ( ): The lease transfers ownership of the asset to the lessee at the end of the lease The lease has a bargain purchase option The lease term is for the major part of the remaining economic life of the asset This can be ignored if the lease begins at or near the end of the asset s useful life The present value of the lease payments, plus the guaranteed residual, amounts to substantially all of the leased asset s fair value The asset is specialized and has no alternative use to the lessor Absent any of these conditions, the lease is treated as an operating lease. 21

22 Identify your leases (continued) Lease classifications What thresholds are used to determine substantially all of the fair value or the major part of the remaining economic life? ASC uses these thresholds: 75% or more is a major part of an asset s remaining economic life 90% or more is substantially all of an asset s fair value An asset is near the end of its economic life when 25% or less of its economic life remains What about the rate used to compute present values? The discount rate is the rate implicit in the lease, or The lessees incremental borrowing rate 22

23 Lessee accounting Let s go deeper

24 Lessee accounting If a lease is less than 12 months, and does not contain a purchase option that is reasonably expected to be exercised, a lease does not have to appear on the balance sheet, i.e. treat as an operating lease under ASC 840 (Short-term Election) If a lease renewal exists that extends the lease beyond 12 months, but is not expected to be exercised, the same treatment applies For the remaining leases, both a Right of Use (RoU) asset and a lease liability will be placed on the balance sheet Both the RoU asset and the liability will generally be recognized at the present value of the remaining lease payments Initial direct costs will also be capitalized as part of the RoU asset Operating leases payments will be recognized as rental expense on a straight-line basis over the lease term Finance Leases rental expense and interest expense will be recognized based on the interest rate, and the RoU asset will be amortized straight-line over the shorter of its useful life or the lease term 24

25 Implementing a lease Create a Right of Use Asset For each lease charge, calculate the Net Present Value for the sum of the flow of payments and the charge s residual value Discount Rate 5.51% Lease Payments: 100,000 Base rent at the end of year 1 110,000 Base rent at the end of year 2 125,000 Base rent at the end of year 3 NPV = 100,000/( ) ^ ,000 /( ) ^ ,000 /( ) ^3 = 94, , ,421 = 300,000 Right of Use Asset Created RoU Asset $300,000 Lease Liability $300,000 27

26 Implementing a lease (continued) Finance lease Calculate Amortization Expense based on NPV of pmts Amortization Expense (Finance Lease) = 300,000 / 3 = 100,000 Calculate Interest Expense 1st year invoice Year 1 Interest Component: 300,000 x 5.51% = 16,535 Year 2 Interest Component: (300, , ,535) x 5.51% = 11,935 Year 3 Interest Component: (300, , , , ,935) x 5.51% = 6,530 Interest Expense 16,535 1st year Interest Component Lease Liability 16,535 1st year Interest Component Amortization Expense 100,000 Amortization expense from the RoU Asset calculation RoU Asset 100,000 Amortization expense from the RoU Asset calculation Lease Liability 100,000 1st year payment AP 100,000 1st year payment 28

27 Implementing a lease (continued) Finance lease Calculate Amortization Expense based on NPV of pmts Amortization Expense (Finance Lease) = 300,000 / 3 = 100,000 Calculate Interest Expense 2nd year invoice Year 1 Interest Component: 300,000 x 5.51% = 16,535 Year 2 Interest Component: (300, , ,535) x 5.51% = 11,935 Year 3 Interest Component: (300, , , , ,935) x 5.51% = 6,530 Interest Expense 11,935 2nd year Interest Component Lease Liability 11,935 2nd year Interest Component Amortization Expense 100,000 Amortization expense from the RoU Asset calculation RoU Asset 100,000 Amortization expense from the RoU Asset calculation Lease Liability 110,000 2nd year payment AP 110,000 2nd year payment 29

28 Implementing a lease (continued) Finance lease Calculate Amortization Expense based on NPV of pmts Amortization Expense (Finance Lease) = 300,000 / 3 = 100,000 Calculate Interest Expense 3rd year invoice Year 1 Interest Component: 300,000 x 5.51% = 16,535 Year 2 Interest Component: (300, , ,535) x 5.51% = 11,935 Year 3 Interest Component: (300, , , , ,935) x 5.51% = 6,530 Interest Expense 6,530 3rd year Interest Component Lease Liability 6,530 3rd year Interest Component Amortization Expense 100,000 Amortization expense from the RoU Asset calculation RoU Asset 100,000 Amortization expense from the RoU Asset calculation Lease Liability 125,000 3rd year payment AP 125,000 3rd year payment 30

29 Implementing a lease (continued) Operating lease Calculate Straight-line Amount i.e. Lease Expense from RoU (100, , ,000)/3 = 111,667 Calculate Interest Expense Year 1 Interest Component: 300,000 x 5.51% = 16,535 Year 2 Interest Component: (300, , ,535) x 5.51% = 11,935 Year 3 Interest Component: (300, , , , ,935) x 5.51% = 6,530 Calculate Amortization Component Year 1 Amortization Component: 111,667 16,535 = 95,132 Year 2 Amortization Component: 111,667 11,935 = 99,732 Year 3 Amortization Component: 111,667 6,530 = 105,137 31

30 Implementing a lease (continued) Operating lease 1st year invoice: Lease Expense 111,667 Lease Expense from the RoU Asset calculation Lease Liability 16,535 1st year Interest Component RoU Asset 95,132 1st year Amortization Component Lease Liability 100,000 1st year payment AP 100,000 1st year payment 2nd year invoice: Lease Expense 111,667 Lease Expense from the RoU Asset calculation Lease Liability 11,935 2nd year Interest Component RoU Asset 99,732 2nd year Amortization Component Lease Liability 110,000 2nd year payment AP 110,000 2nd year payment 3rd year invoice: Lease Expense 111,667 Lease Expense Lease Liability 6,530 3 rd year Interest Component RoU Asset 105,137 3 rd year Amortization Component Lease Liability 125,000 3 rd year payment AP 125,000 3 rd year payment 32

31 And that is the easy part!!! Q. What happens if the lease is based on variable components, for example the escalation is based on CPI? Q. What if a lease is modified or terminated early? Typically, the RoU Asset and Lease Liability need to be restated and the difference goes to a gain or loss account 33

32 Lease vs non-lease components & direct costs

33 Lease / Non-lease components Affects both lessees and lessors Lessees Need to evaluate services, allocate consideration to each component Example: a lease might contain property taxes, and maintenance (CAM). Taxes have no identifiable benefit to the lessee, so can be included in the ROU asset. CAM is a separately identifiable benefit, so is not part of the ROU asset. Base value of non-lease components on their relative stand-alone prices. If indeterminable, might need to ask the lessor. There is a practical expedient that allows, by asset class, for lease and non-lease components to be accounted for together as a single lease component Be careful! If significant, this can dramatically increase the amounts shown on the balance sheet, which might change some financial ratios Basis for Conclusions, paragraph BC14-c, states: "Topic 842 characterizes operating lease liabilities as operating liabilities, rather than debt. Consequently, those amounts may not affect certain financial ratios that often are used in debt covenants." 35

34 Lease / Non-lease components Affects both lessees and lessors Lessors Need to evaluate services, allocate consideration to each component Example: a lease might contain property taxes, and maintenance (CAM). Taxes have no identifiable benefit to the lessee, thus are part of the lease entries & investment. CAM is a separately identifiable benefit, so is not part of the lease investment. Base the value of non-lease components on their relative stand-alone prices. Treat revenue from non-lease components under the guidance of ASC 606 Revenue from Contracts with Customers 36

35 Direct vs Indirect Costs ASC 842 changes the definition of initial direct costs : Costs to negotiate or arrange a lease that would have been incurred regardless of whether the lease was obtained, such as fixed employee salaries, are not initial direct costs. Example of costs allowed ( ) Commissions Payments made to an existing tenant to incentivize that tenant to terminate its lease Example of costs not allowed ( ) General overhead, including depreciation, occupancy and equipment costs, unsuccessful origination time or idle time Costs related to activities performed by the lessor for advertising, soliciting potential tenants, servicing existing leases Costs related to activities that occur before the lease is obtained, such as obtaining tax or legal advice, negotiating lease terms or conditions, or evaluating a potential lessee s financial condition Expensing these latter costs could result in higher expense recognition prior to the lease, as well as higher margins on lease income 37

36 What the experts are saying PwC 10 Minutes on The New Lease Standard

37 What Do I Do? With the changes to both ASC 842 Leases, and ASC 606 Revenue from Contracts with Customers, coming so close together, and the obvious link for Lessors, how do I manage adopting both? The PwC document referenced early suggests you consider these things: Since the standards are so closely aligned, especially for lessors, adopting both concurrently might make sense. This means early adoption of 842 since 606 is applicable in Are your systems and controls ready for early adoption? What are your peers/competitors doing? Will you be the only one to not adopt early? What do your investors prefer? One big change (606 & 842), or one per year (606 in 2018, 842 in 2019)? The interest rate environment do you adopt early using today s interest rate, or wait and use 2019 s? The expedients allow you to hold off certain leases until restructuring or changing leases is required. Should you wait, or do it now? Reporting requirements: both GAAP and IFRS, or just one (the standards are not identical) There are no correct (or wrong) answers, except the ones that are right for your business! 39

38 Steps to prepare PwC 10 Minutes on the New Lease Standard The same PwC document contains six steps to help you prepare: 1.Get every resource on board every department in your organization might be impacted, from IT to tax, to procurement, to operations, to treasury and investor relations. Ensure you budget both cost and resources 2. Break into the filing cabinets inspect and understand your leases, lease terms, renewal options and payments. Examine each lease, or class of lease. Be prepared in multi-asset leases to identify and account for each component as a separate lease. Understand lease and non-lease elements. 3.Assess the impact Do the practical expedients make more sense for your business? Estimate future balance sheet amounts for operating leases. Evaluate your leasing strategy, i.e lease vs buy, short vs long term 40

39 Steps to prepare PwC 10 Minutes on the New Lease Standard The same PwC document contains six steps to help you prepare: 4. Examine and understand regulatory and tax implications 5. Manage the transition do you need to redesign or invest in new systems? Don t forget that testing and implementation take time, so start early 6. Reassess agreements plan to periodically re-evaluate lease terms. Ongoing compliance costs are likely to be higher than today 41

40 Managing leases in Dynamics GP

41 What does that mean for my Dynamics ERP? Managing leases in your MS Dynamics GP ERP requires either Massive, complex Excel spreadsheets; build and track RoU assets & investments and manually JE each period Excel is useful, but cumbersome. (A recent report from the EU found over 50% of all critical spreadsheets in large organizations contained material defects!*) * - European Spreadsheet Risks Interest Group A third party, non-integrated property lease solution - has over 50 different packages What is the upgrade path? Reporting capability? How does it update your GL? Most require manual or integrated JEs to ensure GL is up to date but how up to date? ISV solution Talk to your Dynamics VAR for recommendations Ask your peers on the GPUG Forum what they are doing 43

42 Questions to Ask Yourself / Your VAR Will my ERP handle this today? Hint: GP cannot! So, do you have the Excel skills/time? Will the recommended solution automatically calculate and build the RoU asset and liability at the correct values, or do I have to do it manually? Will the recommended solution handle the new reporting requirements? Will the recommended solution assist with easing the implementation? Is the recommended solution GP integrated, or will I have to use manual integrations and journal entries to update my GL? Will the GL be up to date real time or only after a data synchronization? Can my VAR train me and support me on whatever solution I choose? No right or wrong answers except what works for you but ASK! 44

43 Binary Stream s Property Management Fully integrated lease management module for Dynamics GP (D365 F&O coming in 2019!) Designed for lessors or lessees Commercial, retail, residential applications Build and manage complex lease payment escalations Percent, or sales based, rent Common Area Maintenance reconciliation Automatic creation of Right of Use Asset and Lease Liability Adjustment and true up of RoU Asset and Lease Liability when lease terms and conditions change In-depth reporting Report Writer, or SSRS 45

44 Binary Stream s Property Management Screenshots 46

45 Summary Lease Accounting under ASC 842 Reviewed ASC 842 Lease classification examples Lessee accounting examples What you need to know to get ready! How to handle ASC 842 in Dynamics GP Binary Stream s PrM 47

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47 For more ASC 842 information and GP solutions Cady Jackson Client Account Manager P M NexTecGroup.com