Accounting and Auditing. Norman Mosrie, CPA, FMFMA, CHFP James Sutherland, CPA

Transcription

1 Accounting and Auditing Norman Mosrie, CPA, FMFMA, CHFP James Sutherland, CPA

2 Leases (ASU ; Topic 842) A lease contract conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration 2

3 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

4 Key Questions in Accounting for Leases Do I have a lease? WHY ASK If not within scope of lease standard, must look to different ASC What is the term? Required for initial accounting What is the discount rate? Required for subsequent accounting Any non-lease components? Account for non-lease components differently

5 Key Questions in Accounting for Leases Do I have a lease? What is the term? What is the discount rate? Any non-lease components? 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.

6 Key Questions in Accounting for Leases Do I have a lease? What is the term? What is the discount rate? Any non-lease components? GUIDANCE 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.

7 Key Questions in Accounting for Leases GUIDANCE Do I have a lease? What is the term? 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 What is the discount rate? Any non-lease components? If rate can not be determined, use incremental borrowing rate Private companies may use risk-free rate

8 Key Questions in Accounting for Leases GUIDANCE Do I have a lease? What is the term? What is the discount rate? Any non-lease components? 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

9 Lessee Accounting Overview Balance Sheet Income Statement Cash Flow Statement Finance ( Type A ) Right-of-use (ROU) asset Lease liability Amortization expense Interest expense Cash paid for principal and interest payments Operating ( Type B ) Right-of-use (ROU) asset Lease liability Single lease expense on a straight-line basis Cash paid for lease payments Classification is similar to the classification in Topic 840 Recognition and measurement exemption for short-term leases Other than public business entities may use risk-free rates for measurement of all lease liabilities 9

10 Finance vs. Operating Lease FINANCE LEASE OPERATING 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

11 Finance Lease: Initial Accounting Assets aaaa ROU asset aaaa $ xxx,xxxx Liabilities bbbb Lease liability ROU Asset: - Represents the lessee s right to the use of the leased asset over the lease term bbbb cccc $ xxx,xxxx Equity $ xxx,xxxx Lease Liability: - Represents the lessee s contractual obligation to make lease payments over the lease term

12 Finance Lease: Initial Measurement

13 Finance Lease: Subsequent Accounting Sales Cost of Sales Expenses aaaa Depreciation Interest aaaa Net Income $ xxx,xxxx $ x,xxxx $ x,xxxx $ x,xxxx $ x,xxxx $ xxx,xxxx Income Statement Depreciate ROU asset, straight line over useful life or lease term Recognize interest expense related to lease liability

14 Finance Lease: Subsequent Accounting aaaa aaaa Interest expense Cash from operating activities bbbb bbbb bbbb Cash from investing activities Principal payments cccc Cash from financing activities Change in cash Beginning cash Ending cash $ xxx,xxxx $ xxx,xxxx $ xxx,xxxx Cash Flow Statement Interest expense reported as operating activity Lease principal payments reported as financing activity

15 Operating Lease: Initial Accounting aaaa ROU asset aaaa bbbb Lease liability bbbb cccc Assets $ xxx,xxxx Liabilities $ xxx,xxxx Equity $ 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

16 Operating Lease: Subsequent Accounting Assets aaaa ROU asset aaaa $ xxx,xxxx Liabilities bbbb Lease liability bbbb $ xxx,xxxx Remeasure asset Asset equal to lease liability adjusted for - Prepaid or accrued lease payments - Remaining lease incentives - Unamortized initial direct costs - Asset impairment cccc Equity $ xxx,xxxx Remeasure liability Liability equal to PV of remaining lease payments at discount rate determined at inception

17 Operating Lease: Subsequent Accounting Sales Cost of Sales $ xxx,xxxx Expenses aaaa aaaa Lease expense aaaa Net Income $ x,xxxx $ x,xxxx $ x,xxxx $ x,xxxx $ xxx,xxxx Income Statement Single lease expense, same as current GAAP

18 Operating Lease: Subsequent Accounting aaaa aaaa Lease expense Cash from operating activities bbbb bbbb bbbb Cash from investing activities $ xxx,xxxx $ xxx,xxxx Cash Flow Statement Lease expense reported as an operating activity cccc cccc Cash from financing activities Change in cash Beginning cash Ending cash $ xxx,xxxx

19 Finance Lease: Walkthrough Company leases equipment. Facts: Lease term: 60 months with option to extend for 24 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 $130,320 ROU Asset Lease Liability Cash $ 139,820 $ 130,320 $ 2,500 $ 7,000

20 Finance Lease: Walkthrough Subsequent accounting in year one (excluding lease payments) ROU asset depreciated straight line over 5 year lease term. $139,820 5 = $27,964 Interest expense using interest method and 5.25% discount rate: $6,248 Annual lease payments $30,000 ROU Asset Lease Liability Depreciation Expense Interest Expense $ 139,820 $ 27,964 $ 30,000 $ 130,320 $ 27,964 $ 6,248 $ 111,856 $ 6,248 $ 106,568 Cash $ 30,000

21 Operating Lease: Walkthrough Company leases equipment. Facts: Lease term: 60 months with option to extend for 24 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 $130,320 ROU Asset Lease Liability Cash $ 139,820 $ 130,320 $ 2,500 $ 7,000

22 Operating Lease: Walkthrough Subsequent accounting in year one 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: $6,248 Remaining expense amount is credited against the ROU asset. $31,400 - $6,248 = $25,152 Annual lease payments $30,000 ROU Asset Lease Liability Lease Expense $ 139,252 $ 25,152 $ 30,000 $ 130,320 $ 31,400 $ 114,100 $ 6,248 $ 106,568 Cash $ 30,000

23 Lessor Accounting Overview Balance Sheet Income Statement Cash Flow Statement Sales- Type & Direct Financing Net investment in the lease Interest income and any selling profit on the lease 1 Cash received for leases Operating Continue to recognize underlying asset Lease income, typically on a straight-line basis Cash received for leases Classification is similar to the classification in Topic Selling profit is recognized at lease commencement for sales-type leases and over the lease term for direct financing leases (note: selling profit is rare for direct financing leases) 23

24 Leases Effective Date Public Companies* Fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (CY 2019; FY ) All Other Organizations Fiscal years beginning after December 15, 2019 and interim periods beginning after December 15, 2020 (CY 2020; FY ) Early Application Permitted for all organizations Modified Retrospective Application Must apply new standard as of beginning of earliest comparable period * Public Companies refers to the following: (1) public business entities, (2) a not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or anover-the-counter market, and (3) an employee benefit plan that files or furnishes statements with or to the SEC (Same Here as Revenue Recognition Standard) 24

25 Transition: Practical Expedients You may be able to elect practical expedients to ease burden of adoption No need to reassess whether expired or existing contracts are or contain leases No need to reassess lease classification for any expired or existing leases No need to reassess initial direct costs for existing leases May use hindsight in determining lease term

26 Possible Implementation Challenges POSSIBLE 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 taxes may be affected New disclosure requirements

27 Implementation Next Steps 1 Inventory all existing lease contracts - Aggregate similar leases to avoid redundant analyses - Identify short term leases that will not be capitalized 2 Assess implementation challenges and options - Existence of substantive substitution rights - Choice of discount rate - Determination of lease term - Practical expedients 3 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

28 Other Activities Of The FASB

29 ASU Reminder! Imputation of Interest Simplifying the Presentation of Debt Issuance Costs Debt issuance costs presented as a direct deduction from the related debt liability rather than as an asset Amortization of debt issuance costs reported as adjustment to interest expense Effective for fiscal years beginning after December 15, Early adoption permitted

30 Private Company Council (PCC) Established in 2012 as an advisory body to the FASB on private company matters Advises the FASB on possible alternatives within GAAP to address needs of users of private company financial statements Any proposed changes to GAAP are subject to endorsement by the FASB

31 Key GAAP alternatives resulting from work of PCC Intangibles Goodwill and Other Interest Rate Swaps Simplified hedge accounting approach for certain swaps Variable Interest Entities Common Control Leasing Arrangements Accounting for identifiable intangible assets in a business combination

32 ASU Income Taxes Balance Sheet Classification of Deferred Taxes Requires deferred income tax assets and liabilities be classified as noncurrent in classified balance sheet, net No change to recognition, measurement, or disclosure requirements Report only one single net noncurrent deferred tax asset or liability Effective dates Public business entities fiscal years beginning after 12/15/16 Including interim periods within those fiscal years Other entities fiscal years beginning after 12/15/17 And interim periods within fiscal years beginning after 12/15/18 See DHG A&A Update Classification of Deferred Taxes

33 Revenue Recognition 33

34 New Revenue Standard - Effective Date Original effective dates - CY 2017 (FY ) for public entities* (including interim) - CY 2018 (FY ) for nonpublic entities (no interim, just annual period; interims in subsequent years) - Nonpublic entities may adopt early, but no earlier than public entities Deferred effective dates - CY 2018 (FY ) for public entities* (including interim) - CY 2019 (FY ) for nonpublic entities (no interim, just annual period; interims in subsequent years) - Early adoption permitted, but not before original effective date * Public entities include NFPs with publicly-traded conduit (or direct) debt 3

35 Revenue Recognition (ASU ; Topic 606) Objective: To develop a single, principle-based revenue standard for US GAAP and IFRS The revenue standard aims to improve accounting for contracts with customers by: Providing a robust framework for addressing revenue issues as they arise Increasing comparability across industries and capital markets Requiring better disclosure Substantially converged with IFRS on major provisions 35

36 Scope All contracts with customers, except Lease contracts Insurance contracts Financial instruments Guarantees Non-monetary exchanges in the same line of business to facilitate sales to customers Contracts not with customers are excluded: Contributions Collaborative arrangements

37 Final U.S. GAAP Model Recognition 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 Steps to apply the core principle: 1. Identify the contract(s) with the customer 2. Identify the performance obligations 3. Determine the transaction price 4. Allocate the transaction price 5. Recognize revenue when (or as) a performance obligation is satisfied 37

38 Final U.S. GAAP Model Disclosure Disaggregation of revenue Qualitative and quantitative * disaggregation of revenue into categories that depict how revenue and cash flows are affected by economic factors Information about contract balances Remaining performance obligations Opening and closing balances * Amount of revenue recognized from contract liabilities * Explanation of significant changes in contract balances * Transaction price allocated to remaining performance obligations * Quantitative or qualitative explanation of when amounts will be recognized as revenue * Interim requirements Quantitative disclosures * * for public entities only

39 NFP Financial Statements Project Presentation of Financial Statements of Not-for- Profit Entities Key objectives Update, not overhaul, the current model Improve net asset classification scheme Improve information in financial statements and notes about: Financial performance Cash flows Liquidity Better enable NFPs to tell their financial story Split into two phases Phase I complete! ASU

40 ASU : Presentation of Financial Statements of Not-for-Profit Entities Changes net asset classifications to two categories Net Assets With Donor Restrictions and Net Assets Without Donor Restrictions New disclosures for board-designated net assets (without donor restrictions) Eliminates Temporarily Restricted NA and Permanently Restricted NA Existing GAAP Unrestricted Temp. Restricted Perm. Restricted New GAAP + Disclosures Without Donor Restrictions Amount, purpose, and type of board designations * With Donor Restrictions Nature and amount of donor restrictions * New disclosure requirement

41 ASU : Presentation of Financial Statements of Not-for-Profit Entities Underwater Endowments Revised net asset classification To be reflected in net assets with donor restrictions rather than in net assets without donor restrictions Enhanced disclosures In addition to aggregate amounts by which funds are underwater (current GAAP), also disclose aggregate of original gift amounts (or level required by donor or law) for such funds, fair value, and any governing board policy, or actions taken, concerning appropriation from such funds. 41

42 ASU : Presentation of Financial Statements of Not-for-Profit Entities Liquidity and Availability of Resources NFPs required to provide: Qualitative information on how an NFP manages its liquid available resources and its liquidity risk (in the notes) Quantitative information that communicates the availability of an NFP s current financial assets at the balance sheet date to meet cash needs for general expenditures (on the face and/or in the notes) 42

43 ASU : Presentation of Financial Statements of Not-for-Profit Entities Quantitative Disclosure for Financial Assets Availability Example Financial assets, at year-end* $ 234,410 Less those available unavailable for general expenditures within one year, due to: Contractual or donor-imposed restrictions: Restricted by donor with time or purpose restrictions (11,940) Subject to appropriation and satisfaction of donor restrictions** (144,500) Investments held in annuity trust (4,500) Amounts held by bond trustees (30,200) Board designations: Quasi-endowment fund, primarily for long-term investing** (36,600) Amounts set aside for liquidity reserve (1,300) Financial assets available to meet cash needs for general expenditures within one year $ 5,370 *Total assets, less nonfinancial assets (e.g., PP&E, inventory, prepaids) **Excludes amounts that have been appropriated for next 12 months that do not have purpose restrictions

44 ASU : Presentation of Financial Statements of Not-for-Profit Entities Expense Reporting Report expenses, either on the face of financial statements or in the notes, by: Function * Natural classification Analysis (disaggregate function by nature) ** * currently required in GAAP ** Board may explore segment reporting instead for HC in Phase II NFPs required to provide qualitative disclosures about methods used to allocate costs among program and support functions

45 ASU : Presentation of Financial Statements of Not-for-Profit Entities Reporting of Investment Return How to present? Net presentation of investment expenses against investment return on the face of the statement of activities Netting limited to external and direct internal expenses May report net return in multiple, appropriately labeled lines (e.g., from different portfolios, in different net asset classes, or in operating versus nonoperating) What to disclose? Disclosure of investment expenses no longer required If reported, carefully label and don t include in expense analysis No longer require disclosure of investment return components

46 ASU : Presentation of Financial Statements of Not-for-Profit Entities Allows operating cash flows to be presented using direct or indirect method Eliminates requirement to reconcile direct method operating cash flows to changes in net assets Requires improved presentation / disclosure for operating measure Must report or disclose internal transfers (board designations, appropriations, etc.) that are included in operating measure disaggregated and described by type

47 ASU : Presentation of Financial Statements of Not-for-Profit Entities Effective Date: For fiscal years beginning after 12/15/2017 (e.g., CY 2018, FY ) Interim financials the following year Early Adoption: Permitted, but must apply the regular transition provisions. Transition: For year of adoption: apply all provisions. For comparative years presented: apply all provisions, except can choose not to present: 1) Analysis of expenses by nature and function, and/or 2) Disclosures around liquidity and availability of resources

48 ASU : Important Notes NFPs are already permitted to incorporate many of the changes in the ASU The only changes that cannot be done without formally adopting the ASU are: 1) Presenting one class of restricted net assets (consolidating temporarily and permanently restricted) 2) Underwater endowment accounting 3) Eliminated disclosures of investment return components and netted expenses 4) Eliminated requirement to provide indirect reconciliation if using direct method for operating cash flows

49 ASU : NFP Financial Statements Project Redeliberations Plan

50 Staying Current Best ways to stay current: Sign up for electronic Action Alert FASB on Twitter Pages on FASB website for NFPs Project summaries FASB in Focus executive summaries Podcasts Webcasts 41

51 For questions or assistance Norman C. Mosrie James W. Sutherland