47.1% of organizations concerned about their ability to implement

Transcription

1 Leases: Not Just for the 1 Lease Standard - Statistics 10 year project In 2014, $3.0 trillion in off-balance sheet lease commitments 47.1% of organizations concerned about their ability to implement 2 DHG Birmingham CPE Seminar 1

2 Today s Presenter: Brian Matney, Manager Brian Matney is an audit manager in the Birmingham, Alabama office of DHG. Since joining the firm in 2010, Brian has provided assurance services in the form of financial statement audits, reviews, and compilations and has focused on serving the healthcare industry. As a result of his full-time dedication to the healthcare industry, Brian serves organizations across the entire continuum of care. In addition to audits conducted under generally accepted auditing standards in the United States of America, Brian is experienced in audits under Governmental Auditing Standards. Education University of Alabama, Bachelor of Business Administration, Accounting University of Alabama, Master of Accountancy 3 Objective of the Session Upon conclusion of the presentation you should be able to: Explain the main differences between current lease accounting standard and the new standard Identify working definitions of the key concepts necessary to apply the new lease accounting standard Describe the lessee s initial accounting for a lease Develop an outline of a company-specific plan for implementing the new standard 4 DHG Birmingham CPE Seminar 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 5 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? What is the discount rate? Required for initial accounting Required for subsequent accounting Any non-lease components? Account for non-lease components differently 6 DHG Birmingham CPE Seminar 3

4 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? 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. 7 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. 8 DHG Birmingham CPE Seminar 4

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 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 If rate can not be determined, use incremental borrowing rate Private companies may elect a policy for all leases to use riskfree discount rate 9 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 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 10 DHG Birmingham CPE Seminar 5

6 Polling Question How prepared is your organization to implement the new lease standard? a. Feeling good about it. b. Thinking about it, but haven t started it. c. There s a new lease standard? 11 Finance vs. Operating Lease Classification 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 12 DHG Birmingham CPE Seminar 6

7 Initial Measurement 13 Initial Measurement Very narrowly defined excludes costs that would have been incurred regardless of whether the lease was obtained 14 DHG Birmingham CPE Seminar 7

8 Finance Lease: Initial Accounting ROU asset Assets ROU Asset: - Represents the lessee s right to the use of the leased asset over the lease term Liabilities Lease liability Equity cccc Lease Liability: - Represents the lessee s contractual obligation to make lease payments over the lease term 15 Finance Lease: Subsequent Accounting Sales Cost of Sales Expenses Amortization Interest Net Income $ x,xxxx $ x,xxxx $ x,xxxx $ x,xxxx Income Statement Amortize ROU asset, straight line over useful life or lease term Recognize interest expense related to lease liability 16 DHG Birmingham CPE Seminar 8

9 Finance Lease: Subsequent Accounting Interest expense Cash from operating activities Cash from investing activities Cash Flow Statement Interest expense reported as operating activity Principal payments cccc Cash from financing activities Change in cash Beginning cash Ending cash Lease principal payments reported as financing activity 17 Operating Lease: Initial Accounting Assets ROU asset Liabilities Lease liability Equity cccc 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 18 DHG Birmingham CPE Seminar 9

10 Operating Lease: Subsequent Accounting Assets ROU asset Liabilities Lease liability Equity cccc ROU asset Asset equal to lease liability adjusted for - Prepaid or accrued lease payments - Remaining lease incentives - Unamortized initial direct costs - Asset impairment Liability Liability equal to PV of remaining lease payments at discount rate determined at inception 19 Operating Lease: Subsequent Accounting Sales Cost of Sales Expenses Lease expense Net Income $ x,xxxx $ x,xxxx $ x,xxxx $ x,xxxx Income Statement Single lease expense, same as current GAAP recognized straightline over the lease term 20 DHG Birmingham CPE Seminar 10

11 Operating Lease: Subsequent Accounting Lease expense Cash from operating activities Cash from investing activities Cash Flow Statement Lease expense reported as an operating activity cccc cccc Cash from financing activities Change in cash Beginning cash Ending cash 21 Finance Lease: Walkthrough Company leases equipment. Facts: Lease term: 60 months with option to extend for 24 months 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 $129,752 ROU Asset Lease Liability Cash $ 139,252 $ 129,752 $ 2,500 $ 7, DHG Birmingham CPE Seminar 11

12 Finance Lease: Walkthrough Cash Subsequent accounting in year one $ 27,500 Lease payments made during the year: $27,500 ROU asset depreciated straight line over 5 year lease term. $139,252 5 = $27,850 Interest expense using effective interest method and 5.25% discount rate: $5,773 ROU Asset $ 139,252 $ 27,850 $ 111,402 Depreciation Expense $ 27,850 Interest Expense $ 5,773 Lease Liability $ 27,500 $ 129,752 5,773 $ 108, 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 $129,752 ROU Asset Lease Liability Cash $ 139,252 $ 129,752 $ 2,500 $ 7, DHG Birmingham CPE Seminar 12

13 Operating Lease: Walkthrough Subsequent accounting in year one Remaining lease payments made during the year: $27,500 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: $5,773 Remaining expense amount is credited against the ROU asset. $31,400 - $5,773 = $25,627 Lease Expense $ 31,400 Cash $ 27,500 ROU Asset $ 139,252 $ 25,627 $113,625 Lease Liability $ 27,500 $ 129,752 5,773 $ 108, Lessor Accounting: What s the Same Lessor accounting largely unchanged from current OPERATING LEASE CLASSIFICATION + Most operating leases remain operating leases + Current lease classification is retained as well as accounting for each type 26 DHG Birmingham CPE Seminar 13

14 Lessor Accounting: What s Changed Classification changed to align with lessee guidance model conditions are met Same classification criteria as finance lease in lessee Lessor to classify as direct financing if certain Operating leases + Incremental tests for leases involving real estate were removed + Leveraged leases no longer exist unless commenced prior to adoption 27 Transition: Effective Dates Effective dates for public companies + Fiscal years beginning after December 15, 2018, including interim periods i.e., calendar 2019 starting in Q1 Effective dates for private companies + Fiscal years beginning after December 15, 2019 i.e., calendar 2020 year-end and calendar 2021 interim statements Modified retrospective application with optional practical expedients + Must apply new standard as of beginning of the earliest period presented 28 DHG Birmingham CPE Seminar 14

15 Transition: Practical Expedients You may be able to elect practical expedients to ease burden of adoption You do not need to You may Reassess whether expired or existing contracts are or contain leases Reassess lease classification for any expired or existing leases Reassess initial direct costs for existing leases May use hindsight in determining lease term 29 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 income taxes may be affected New disclosure requirements 30 DHG Birmingham CPE Seminar 15

16 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 31 DHG Birmingham CPE Seminar 16