ARE YOU READY TO ADOPT ASC 842? February 28, 2018

Transcription

1 ARE YOU READY TO ADOPT ASC 842? February 28, 2018

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4 ARE YOU READY TO ADOPT ASC 842? February 28, 2018

5 Presenters Kristin McLaughlin Senior Director, RSM US LLP Rich Stuart Partner, RSM US LLP Kim Susko Director, RSM US LLP Scott Vanlandingham Principal, RSM US LLP

6 Agenda Topics Minutes Overview of the standard 15 Transition to the new standard 10 Panel discussion 30 Starting an implementation process 5

7 OVERVIEW OF THE STANDARD

8 Overview of key changes - Lessees Recognition of all leases with an original term of greater than 12 months on balance sheet The critical accounting determination will be whether a contract contains a lease. The lease classification distinction will affect how lessees measure and present lease expense and cash flows not whether the lease is on or off-balance sheet as it does under current U.S. GAAP. Classification as operating or finance lease is based on criteria similar to, but not identical to, those in current U.S. GAAP. A lessee will recognize a right-of-use (ROU) asset and a lease liability for all leases, including operating leases, with a term greater than 12 months. Entities will be required to perform ongoing evaluation of ROU assets for impairment The new standard has a narrow definition of initial direct costs. Some costs incurred in negotiating and arranging a lease that are capitalized under current U.S. GAAP will now be expensed when incurred.

9 Overview of key changes - Lessees Separation of lease and non-lease components If there are lease and non-lease components (e.g., services), an entity applies the new standard to the lease components and other U.S. GAAP to the non-lease components, unless a lessee elects (by class of underlying asset) to account for non-lease components as part of the lease component to which they relate. The consideration in the contract is allocated to the lease and non-lease components on a relative standalone price basis, maximizing the use of observable information. Executory costs that do not represent payments for a good or service (e.g., payments to cover the lessor s costs of ownership, such as property taxes or insurance) are not considered non-lease components and, therefore, will be allocated to the lease and non-lease components in the same manner as all other payments in the contract (i.e., will not be excluded from lease accounting as they are under current U.S. GAAP).

10 Overview of key changes - Lessees Expanded disclosures The disclosure objective of ASC 842 is to provide the financial statement users sufficient information to assess the amount, timing and uncertainty of cash flows arising from leases. Qualitative disclosures, such as information about the nature of leases (terms and conditions of variable lease payments, extension and termination options, purchase options, residual value guarantees, etc.). Quantitative disclosures, such as operating lease cost, amortization of finance lease ROU assets and interest on finance lease liabilities, variable lease cost, weighted-average remaining lease term, weighted-average discount rate, and a maturity analysis of lease liabilities.

11 Overview of key changes - Lessees Other transactions ASC 842 eliminates sale-leaseback accounting as an off-balance sheet financing proposition as the seller-lessees will recognize a ROU asset and a lease liability for the leaseback. The new standard eliminates the current build-to-suit lease accounting guidance and, instead, stipulates that a lessee is the accounting owner of an asset under construction when it controls that asset before the lease commencement date rather than whether the lessee takes on risks during the construction period. Under ASC 842, if the lessee controls the asset during construction, the asset is capitalized as construction-in-progress and is subject to the sale and leaseback guidance at the end of construction. The transition provisions of the new standard will permit many entities to derecognize build-to-suit assets and liabilities that have remained on the balance sheet after the end of the construction period under current U.S. GAAP.

12 Overview of key changes - Lessees Financial metrics, key performance indicators and capital structure impact Return on assets, debt-to-equity ratios and liquidity Debt covenants, interest coverage ratios and EBITDA/EBIT levels Recognition of foreign currency remeasurement gains and losses related to lease liabilities that are denominated in a currency that is different from a Company s functional currency Tax Recognition of lease-related assets and liabilities that are not on the balance sheet today would impact certain aspects of accounting for income taxes, such as: Recognition and measurement of deferred tax assets and liabilities Assessment of recoverability of deferred tax assets and liabilities Uncertainty around whether the ROU asset would be: State and local tax: Included in the property factor for apportionment of income Sales and use tax: Subject to sales tax Property tax: Included in property tax base

13 Overview of key changes - Lessors Same basic lessor accounting model is retained with some nuances Lease classification A lessor will classify leases as (1) sales-type, (2) direct financing or (3) operating using criteria similar to current U.S. GAAP. Leveraged lease classification, however, will be eliminated prospectively. Unlike current U.S. GAAP, leases with predominantly variable payments may be classified as sales-type or direct financing leases. Collectibility uncertainties Unlike current U.S. GAAP, a lease with collectibility uncertainties can be classified as a sales-type lease. If collectibility of the lease payments, plus any amount necessary to satisfy a lessee residual value guarantee, is not probable for a sales-type lease, lease payments received are recognized as a deposit liability (i.e., not recognized as lease income) and the underlying asset is not derecognized generally until collectibility of the remaining amounts becomes probable. Collectibility uncertainties for a lease that otherwise would be a direct financing lease result in operating lease classification. Lease income recognized for operating leases when collectibility is not probable is limited to cash received from the lessee until collectibility of the remaining lease payments becomes probable.

14 Overview of key changes - Lessors Expanded disclosures Qualitative Information about leases Nature of variable payment arrangements Termination, renewal, and purchase options Information about how the lessor manages residual asset risk, including information about residual value guarantees and other means of limiting that risk Significant accounting judgments and estimates Quantitative Maturity analysis of lease receivables for sales-type/direct financing leases and of lease payments for operating leases Table of lease income Selling profit (or loss) recognized at lease commencement and interest income for salestype/direct financing leases Operating lease income Variable lease income

15 TRANSITION TO THE NEW STANDARD

16 Effective date and transition SAB Topic 11.M Effective Early adoption permitted Prior periods presented Public Business Entities Prior periods presented All other entities The transition provisions are applied using a modified retrospective approach. The FASB issued a proposed ASU in 1/18 to allow another transition method in addition to the existing requirements to transition to the new lease standard by recognizing a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption consistent with the request by preparers. This additional transition method would change when an entity would be required to initially apply the transition requirements of the new lease standard; it would not change the date of adoption or how those requirements apply. Private companies are required to adopt on 1/1/20

17 Practical expedients Lessees and lessors are permitted to make an election to apply the package of practical expedients and/or the hindsight practical expedient Package of expedients (1) (2) Do not re-assess: Whether contracts are or contain leases Lease classification Whether initial direct costs qualify for capitalization Hindsight expedient Use hindsight when determining the lease term and assessing impairment of ROU assets (lessees only) (1) Practical expedient may be elected separately or in conjunction with the hindsight expedient. (2) Must elect as a package and must be consistently applied to all leases.

18 Accounting policy elections Certain accounting policy elections related to leases must be made and documented: - Short-term leases (term of less than 12 months) are excluded from recognition and recognized over the lease term - Requires careful evaluation of renewal options - By class of underlying asset, choose not to separate nonlease components from lease components - Discount rate (non-public Business Entities) can choose to use a riskfree discount rate for the lease, determined using a period comparable with that of the lease term, instead of incremental borrowing rate related to leased asset - Portfolio approach--may apply guidance to a portfolio of leases with similar characteristics (size and composition) if reasonably expect that the application of the leases model to the portfolio will not differ materially from the application to the individual leases in that portfolio.

19 PANEL DISCUSSION

20 WHAT ARE SOME OF THE KEY ESTIMATES AND JUDGMENTS COMPANIES WILL NEED TO MAKE WHEN ADOPTING ASC 842?

21 Key estimates and judgments to consider Does the contract meet the definition of a lease? Are there non-lease components in the contract? What is the lease term, considering renewal, termination and purchase options? Do we have a lease modification? Are there variable lease payments and residual value guarantees? What is the discount rate? What is the relative standalone prices of the lease and non-lease components? Does the transaction qualify for sales-leaseback accounting?

22 WHAT KEY FUNCTIONS WITHIN A COMPANY SHOULD BE INVOLVED WITH IMPLEMENTATION EFFORTS?

23 Cross functional implementation team Corporate accounting (lease accounting and financial reporting) IT Procurement Tax Internal audit/sox FP&A Treasury Real estate management/lease administration Legal

24 WHERE SHOULD COMPANIES BE NOW IN ORDER TO MEET THE PUBLIC COMPANY DEADLINE?

25 Time-box is shrinking for controllerships Time-box: Lease Accounting Project Projects take 3-6 months (depending on size and complexity of company and leasing portfolio) Panic Window It s upon us! SOX 404 Lockdown Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q Transition Deadline Source: LeaseAccelerator Inc. Page 25

26 WHAT ARE THE KEY IMPLEMENTATION CHALLENGES COMPANIES ARE FACING?

27 Implementation challenges Completeness of lease data including the identification of embedded leases Decentralized data Decentralized processes Low quality and difficult to read documentation Complex and time consuming agreements High volume of leases Validation of accounting calculations Implementation of new IT applications, processes and controls Significantly more judgments and estimates Interaction with other guidance (new revenue standard)

28 WHY SHOULD COMPANIES CONSIDER A TECHNOLOGY SOLUTION?

29 Need for technology solutions Future state requirements Calculate Lease liability based on NPV of future payments Calculate ROU Asset account with adjustments based on lease classification and other factors Determine/schedule payments (rent, lease payment) including non-lease factors such as interest, taxes, CAM, etc. Workflow to monitor reassessment triggers Other aspects: Contract & Document Management, Facilities Management, Project Management

30 Need for technology solutions (cont.) Variable factors by lease Lease types/re vs. equipment Lease classification (finance vs. operating) Lessor vs. lessee or both Lease and non-lease components allocation to lease vs. nonlease Subleases %-Rent Escalating payments/step-ups Lease re-assessments/triggers Lease modifications same contract or distinct Options renewal, purchase, termination

31 WHAT ARE THE KEY CRITERIA COMPANIES SHOULD BE CONSIDERING WHEN CHOOSING A TECHNOLOGY SOLUTION?

32 Key selection criteria During the selection process, vendors may be evaluated based on the following high-level criteria: Criteria Ability to meet requirements Technical architecture/ease of integration Functional fit/ Ease of use Description Assessment of the strengths of the software application relative to lease accounting requirements. Included within this criteria is the ability of the product to meet demonstration requirements and overall ease of use. How capable is the solution of integrated within the broader ERP environment Key considerations related to functional fit within core processes and ease of use by the end users Ability to execute Complexity of implementation, stability of latest version of the product, availability of skilled implementers and developers Pricing and cost Summary of prices, terms, and total cost of ownership

33 WHAT ARE SOME COMMON PITFALLS WHEN COLLECTING DATA?

34 Upstream data sources Identification of the gaps between data captured in existing software tools and the required data fields helps expedite the implementation of the software solution. For asset-level data extraction, assess missing or incomplete fields, incorrect and inconsistent data, and solutions for gaps in the lease processes. Upstream Sources Confirm All Potential Data Sources Lessee or Lessor Systems Real Estate Management Application IT Asset Management System Fleet Management Application Procurement & Sourcing System Accounts Payable Applications Regional or Business Unit Spreadsheets Lease Contract Assessment of Current Processes Understanding lease types, asset classes, and lease lifecycle Understanding the organizational structure and how it relates to the current processes Data Collection Challenges Decentralized Leasing Process: Who is the asset owner? Where is the data? Liaison to navigate touchpoints of lease throughout lifecycle Asset-Level Tracking: A supercomputer lease might consist of 50 different assets which need to be tracked separately for IFRS 16 and ASC 842 Understanding requirements of asset-level tracking as leases move on balance sheet Embedded & Complex Leases: What outsourcing and service contracts exist that may include embedded leases? Examination of A/P invoices, vendors, contracts Assess complex leases within the portfolio and develop a checklist of what data needs to be collected

35 Data collection - common pitfalls Data aggregation, data cleanliness and dedicated resources are the three characteristics that drive the timeliness and success of the lease data collection effort. When data is unorganized across the organization with greatly varying types of leases and levels of complexity, additional resources are needed to ensure the timeline is accurate and achievable. Optical character recognition (OCR) myths: Myth OCR will reduce the overall time to required for data aggregation projects Fact Electronic data extraction requires additional data validation due to the inconsistent nature of lease data fields, extraction accuracy and nuanced language in non-standard lease agreements Myth OCR will eliminate the need for manual data extraction and review Fact While accelerating the extraction of the lease data, relying on OCR obfuscates the fact of every individual lease requiring attention and analysis

36 Data collection - Common pitfalls (cont.) Common challenges and hurdles include: Lack of a centralized database of current contracts or master lease agreements ( MLA ) makes it difficult to track down all documents Many multiples of contract format (causes complications in electronic data extraction and/or causes more time required to extract data from contract manually) Incomplete data in contract and/or MLA Data extraction errors - manual or electronic extraction (must have an audit process) Lack of available resources - extra staff or more time from current staff needed to manually extract/audit data or audit electronically extracted data

37 STARTING AN IMPLEMENTATION PROCESS

38 ASC 842 approach Assessment and Strategy Project Initiation and Planning Business Requirements 842 Impact Assessment Operational & Technology Strategy Plan impact assessment Understanding of business strategy, organizational overview, business systems Current lease portfolio Contracts deep dive Current org design Current tech landscape Current biz processes Key impacts of ASC 842 Critical gaps External auditor findings Define requirements Evaluate vendors Select vendor Define implementation scope, timeline and budget Implementation Management Business Process & System Design Lease Abstraction & System Configuration System Testing and Validation Deployment, Training and User Adoption Detailed system design Templates and tools Stakeholder impact (tax, treasury) Configure software Abstract leasing data Feedback from external auditors Testing plan Execution of test plan Validation of lease calculations Issue tracking Training for accounting users (optional) Training for procurement users (optional) Internal controls (optional) Project Management, Communication and Change Enablement

39 Additional insights

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