GAAP UPDATE DEANA BOWDEN, CPA, MSA WHITE NELSON DIEHL EVANS LLP

GAAP UPDATE DEANA BOWDEN, CPA, MSA WHITE NELSON DIEHL EVANS LLP

TOPICS 2016-02 Topic 842 Leases 2016-14 Topic 958 Not for Profits 2016-18 Topic 230 Cash Flows

LEASES Current US Generally Accepted Accounting Principles (GAAP) as prescribed by Accounting Standards Codification (ASC 840) focuses on whether the lease transfers substantially all of the risks and rewards of ownership. The new guidance, codified as ASC Topic 842, Leases, introduces a right-of-use model, which shifts from the risks and rewards approach to a controlbased approach.

LEASES BIG PICTURE: WHAT S CHANGING? The new leases standard will increase transparency and comparability among organizations that lease buildings, equipment, and other assets by recognizing the assets and liabilities that arise from lease transactions. In other words, current off-balance sheet leasing activities will be required to be reflected on balance sheets so that investors and other users of financial statements can more readily and accurately understand the rights and obligations associated with these transactions. If the lessee does not have the right to control the use of an identified asset, then the arrangement may not qualify as a lease. The FASB lessee accounting model retains two types of leases, and is consistent with the lessee accounting model under existing GAAP. One type of lease (finance leases) will be accounted for in substantially the same manner as capital leases are accounted for under existing GAAP. Additionally, if the asset is so specialized that it isn t expected to have an alternative use at the end of the term - then it is a finance lease.

LEASES The other type of lease (operating leases) will be accounted for (both in the income statement and statement of cash flows) in a manner consistent with operating leases under existing GAAP. However, as it relates to the balance sheet, lessees will recognize lease liabilities based upon the present value of remaining lease payments and corresponding lease assets for operating leases with limited exception. The new leases standard also will require lessees and lessors to provide additional qualitative and quantitative disclosures to help financial statement users assess the amount, timing, and uncertainty of cash flows arising from leases. These disclosures are intended to supplement the amounts recorded in the financial statements so that users can understand more about the nature of an organization s leasing activities. NOTE: No major changes for lessors.

LEASES Initial steps to plan for the road ahead may include: Understand the accounting requirements Understand the lease population (e.g., by type, system, and location) Develop an implementation roadmap that includes all impacted areas

LEASES What are some of the expected impacts? Enhanced disclosure requirements both quantitative and qualitative. This includes information about significant judgments and assumptions Financial ratios may change with potential impacts to debt covenants or other guarantees The Board decided that a modified retrospective approach for transition, as opposed to a full retrospective approach, provides an appropriate balance between minimizing costs of transition and providing users of financial statements with comparable financial information. The practical expedients related to transition, if elected, should further significantly reduce the costs associated with transitioning to the new requirements.

FINANCE LEASES Finance Lease - We knew as a capital lease a Sales Type Lease Bright lines gone, old rules still a guideline Transfer ownership at end of lease Bargain purchase option The lease term is for the major part of economic life The PV of lease pmts equals or exceeds fair value Assets is specialized and expected to have no alternative use

RIGHT OF USE LEASES Right of Use lease We knew as an operating lease Requires lessees to record assets and liabilities on the balance sheet for almost every lease Asset = ROU asset Liability = Lease Liability ROU asset and liability recorded at Present Value Lease expense Straight-line expense No interest or depreciation expense Lease expense included in EBITDA

RIGHT OF USE LEASES If we don t know the rate implicit in the lease, use your incremental borrowing rate to calculate the present value of the lease payments Vehicle rates (reputable site bankrate.com) Office equipment rates (reputable site agdirect.com) Building rates (current borrowing rate or prime rate as a starting point) Indirect costs, non lease component (i.e. maintenance portion should be separated out estimate if necessary) Executory costs, such as those for property taxes or insurance are part of lease payments used to calculate the lease liability and ROU asset At lease commencement, the lessee records exactly the same initial journal entry recorded under a finance lease Must be separately stated from assets actually own

SHORT TERM LEASES Lessees can elect not to recognize short-term leases on their balance sheet under ASC Topic 842 and instead account for them as executory contracts, which is similar to the accounting for operating leases under legacy GAAP. The accounting policy election for short-term leases must be made by class of underlying asset. A short-term lease is one with a maximum lease term of 12 months or less that doesn t include an option to purchase the underlying asset that the lessee is reasonably certain to exercise. Careful consideration is required when evaluating whether a lease has a maximum term of 12 months or less. For example, a month-to-month lease (whether for equipment or facilities) may not qualify as a shortterm lease if the lessee is economically compelled to renew the lease beyond the next 12 months. This could occur because: The leased asset is of a specialized nature and difficult to replace. The leased asset is necessary to fulfill customer orders under a longterm contract, so it s commercially disruptive to exit the lease.

SHORT TERM LEASES Regarding the second bullet, an example: Assume DGH leases its headquarters building and warehouse from a relatedparty entity on a month-to-month basis. Although the lease agreement is between related parties and is for nonunique facilities, the lease may still not qualify as short-term if it s commercially disruptive or expensive for DGH to relocate. In other words, if DGH is economically compelled to extend the lease for more than 12 months, the arrangement doesn t qualify for the short-term lease policy election under ASC Topic 842. Other examples could include significant lessee investments in leasehold improvements, a high degree of integration of the leased asset, or regulatory certification or approval of systems that incorporate the leased asset. There are NO scope exceptions for small-ticket items such as automobiles, computers, or even copiers. These must be accounted for using an asset and liability approach under ASC Topic 842, provided the lease term is more than 12 months. However, lessees are allowed to account for leases on a portfolio basis. For example, a lessee may group together copier lease contracts entered into around the same time and under similar lease terms. Similarly, leases for a bundle of laptops or even for a fleet of cars may qualify for the portfolio accommodation.

EXAMPLES OF COMPANY X LEASES AS IF IMPLEMENTING JUNE 30, 2016 Building One Building lease short term annual rent increases Fleet i.e. Enterprise Vehicle lease Copier Office equipment lease Building Two Month to month lease Impact to balance sheet of all leases

BUILDING ONE 4 th amendment two years June 1, 2016 to May 31, 2018 $1969.92 June 1, 2016 to May 31, 2017 $2039.04 June 1, 2017 to May 31, 2018 These 24 payments total $48,107.52 Assume incremental borrowing rate at prime 3.5% The present value is $46,383.10 The straight-line expense is $2004.48 per month ($48,107.52/24) Initial Journal entry Right Of Use Asset $46,383.10 Lease Liability $46,383.10 Year 1 journal entry Lease expense $2,004.48 Lease liability $1,834.64 Right of Use Asset $1,869.20 Cash $1,969.92

BUILDING ONE Year 2 journal entry Lease expense $24,053.76 Lease liability $22,506.62 Right of Use Asset $22,852.22 Cash $23,708.16 Year 3 journal entry Lease expense $22,049.28 Lease liability $22,041.84 Right of Use Asset $21,661.68 Cash $22,429.44 The expense is the same as the operating lease, however, the balance sheet assets and liabilities increased for the duration of the lease period.

FLEET LEASE 2014 Chevy October 16, 2013 to October 16, 2017 (48 months) $783.84 monthly payment At June 30, there are 16 payments left Borrowing rate at 10.3% To calculate borrowing rate calculate total lease amount Monthly payment less interest plus 8% sales tax time 48 payments $725.78 less $133.05 = $592.73 x.08 = 47.42 = 640.15 x 48 = 30,727.20 The $30,727.20 is the loan, $783.84 is the payment, 48 is the # pmts, interest is unknown. The present value of 16 payments is $11,671.26 The straight-line expense is $783.84 per month ($12,541.44/16) Initial Journal entry Right Of Use Asset $11,671.26 Lease Liability $11,671.26 Year 1 journal entry Lease expense $9,406.08 Lease liability $8,602.07 Right of Use Asset $8,602.07 Cash $9,406.08

FLEET LEASE Year 2 journal entry Lease expense $3,135.36 Lease liability $3,069.19 Right of Use Asset $3,069.19 Cash $3,135.36

COPIER Copier $939.70 for 58 months At June 30, 2016, there are 22 payments totaling $20,673.40 Assume borrowing rate at 4.95% (assumption from agdirect.com new equipment financed amount between $10k and $150K for 6-7 years) The present value is $19,724.25 The straight-line expense is $939.70 per month ($20,673.4/22) Initial Journal entry Right Of Use Asset $19,724.25 Lease Liability $19,724.25 Year 1 journal entry Lease expense $11,276.40 Lease liability $10,536.97 Right of Use Asset $10,536.97 Cash $11,276.40

COPIER Year 2 journal entry Lease expense $9,397.00 Lease liability $9,187.28 Right of Use Asset $9,187.28 Cash $9,397.00

BUILDING TWO Month to month lease Been there for 30 years No expectation of leaving Must use judgement on the term of the lease for capitalization purposes Must use judgement on the monthly lease amount on a go forward basis (i.e. how often are there rent escalations?) Must use judgement on the incremental borrowing rate. Example of assumptions Seems more likely than not 15 years would not be unreasonable Monthly rent has remained same since 2010 (six year history), seems reasonable to use $4,276 (current rent) Use of prime rate 3.5% Initial Journal entry Right of use asset $598,140 Lease liability $598,140 Year 1 Lease expense $51,312 Lease liability $30,869 ROA $30,869 Cash $51,312 Annual entry to June 2031

IMPACT ON BALANCE SHEET OF ALL LEASES Total ROU and Liability Debit ROU (separately stated on balance sheet) Copiers $ 29,107.33 Buildings $740,880.42 Vehicle $ 11,671.26 Credit ROU Liability $786,659.01 Covenant for Company X is the Debt Service Coverage (ratio of cash available for debt servicing to interest, principal and lease payments NI/annual debt) Lease expense will have same affect as rent expense no change However, annual debt payments for the lease liability will drop our ratio from 1.5 to.92 Company X needs 1.25 to pass We need to review the agreement for a clause regarding changes in the accounting standards and possibly renegotiate the agreement based upon the new ROU liability prior to implementation of the standard

LEASES WHAT S THE EFFECTIVE DATE FOR MY ORGANIZATION?

ASU 2016-14 NOT FOR PROFITS Effective for fiscal years beginning after December 31, 2017. For Company X this will be year ended December 31, 2018. Should be applied retrospective For comparative years apply all provisions but may elect not to include: Disclosures regarding liquidity Expenses by nature and function

ASU 2016-14 NOT FOR PROFITS 1. Net Asset classes 2. Classification of expenses including investment returns 3. Liquidity, both quantitative and qualitative 4. Statement of cash flows 5. Reporting expiration of Capital Restrictions

NET ASSET CLASSES Unrestricted Net Assets BECOMES Without Donor Restrictions Undesignated Board-designated Must disclose amount, purpose and type of board designation Temporarily Restricted Net Assets BECOMES With Donor Restrictions Permanently Restricted Net Assets BECOMES With Donor Restrictions Disclose nature and amount of donor and timing restrictions at end of period and how the restrictions affect the use of resources Includes endowments invested in perpetuity and underwater endowments

STATEMENT OF FINANCIAL POSITION Net Assets [The level of detail presented here is not required, however if the information presented on the face is not sufficiently detailed, it must be included in the notes.] 20x1 20x0 Without donor restrictions Undesignated 3,057,607 1,370,401 Designated by the Board for operating reserve 300,000 250,000 Designated by the Board for endowment 15,511,186 14,912,222 Invested in property and equipment, net of related debt 21,150,885 20,193,878 With donor restrictions 40,019,678 36,726,501 Perpetual in nature 22,864,750 22,450,146 Purpose restrictions 14,228,316 10,351,233 Time-restricted for future periods 1,391,825 1,279,636 Underwater endowments - (42,677) 38,484,891 34,038,338 Total net assets 78,504,569 70,764,839

STATEMENT OF ACTIVITIES Without Donor With Donor Restrictions Restrictions Total Revenue, Support, and Gains Program service fees $ 12,972,526 $ - $ 12,972,526 Exchange portion of membership dues 373,781-373,781 Gift shop sales 112,364-112,364 Less cost of goods sold (59,621) - (59,621) Net gift shop sales 52,743-52,743 Net investment return 1,131,149 3,412,392 4,543,541 Other revenue 101,275-101,275 Federal and state contracts and grants 256,663-256,663 Contributions 3,352,578 2,858,963 6,211,541 Donated professional services 23,555-23,555 In-kind contributions 36,280-36,280 Gross special events revenue 114,989-114,989 Less cost of direct benefits to donors (12,601) - (12,601) Net special events revenue 102,388-102,388

CLASSIFICATION OF EXPENSES INCLUDING INVESTMENT RETURNS All NFPs are required to report information about expenses by both their natural classification and their functional classification in one location, either on the face of the statement of activities, as a schedule in the notes to the financial statements, or as a separate financial. Presenting this information as supplementary information does not meet the requirement. Many already have a statement of functional expenses that shows expenses by their natural classification (salaries, rent, etc) and their functional classification (Program 1, Program 2, etc) This requirement adds information useful to donors, grantors, creditors and others in assessing the degree to which a not for profit s expenses are fixed or discretionary, how the related resources are being allocated, and the costs of the services provided. Investment Return will be reported net of external and direct internal investment expenses and those netted expenses are no longer required to be disclosed. Many already do this these balances are not a material aspect of the financial and due to the immaterial amounts, have been shown net on the Statement of Activities.

STATEMENT OF FUNCTIONAL EXPENSES Expenses: Program Expenses: Program 1 Program 2 Program 3 Program 4 Program 5 Contract expenses 195,643 246,507 3,982 12,438 208,857 Food and supply costs 695,024 1,235,655 29,363 - - Insurance 138,550 147,663 13,232 20,655 6,023 Other program expenses 3,824 4,459 194 733 300 Personnel expense 1,004,753 1,060,329 96,338 147,310 42,522 Transportation and travel 9,550 15,820 23,592 4,797 507 Vehicle and fuel 29,250 42,986 - - - Total Program Expenses 2,076,594 2,753,419 166,701 185,933 258,209 Support Expenses: Depreciation 54,577 61,965 3,907 4,968 6,542 Employment expense 15,339 14,952 1,041 1,586 1,016 Direct mail and fundraising expenses - - - - - Insurance 36,502 41,581 1,748 2,230 - Miscellaneous 1,861 2,561 208 152 127 Office expense 17,490 33,203 1,280 8,991 2 Professional fees 9,763 25,152 1,466 1,466 1,955 Rent - 19,602-13,069 - Repairs and maintenance 20,977 27,902-3,523 - Small equipment 564 - - - - Technology 38,117 26,976 1,202 1,882 113 Telephone and utilities 64,140 82,955 2,710 15,570 220 Total Support Expenses 259,330 336,849 13,562 53,437 9,975

LIQUIDITY, BOTH QUANTITATIVE AND QUALITATIVE Quantitative and qualitative information about liquidity will be required for the purpose of providing financial statement users with an understanding of an entity s exposure to risks, as well as how an entity manages its liquidity risk and information about the availability of assets to meet cash needs for general expenditures within one year of the balance sheet (statement of financial position) date. Quantitative: Presenting a classified balance sheet may be an effective way for organizations to comply with many of the new disclosure requirements. Many WNDE clients already do this.

LIQUIDITY, BOTH QUANTITATIVE AND QUALITATIVE Qualitative: Note disclosure that indicates how they manage their liquid available resources To meet cash needs for general expenses within one year of the balance sheet date As part of our liquidity management plan, we invest cash in excess of daily requirements in short-term investments, CDs, and money market funds. Occasionally, the Board designates a portion of any operating surplus to its operating reserve, which was $300,000 as of December 31, 201X. Our board-designated endowment of $15,511,186 is subject to an annual spending rate of 4.5 percent as described in Note 9. Although we do not intend to spend from this board-designated endowment (other than amounts appropriated for general expenditure as part of our Board s annual budget approval and appropriation), these amounts could be made available if necessary. Verify if Company has an investment policy may need to expand for specifics for footnote disclosure

STATEMENT OF CASH FLOWS Not for profit entities can continue to present the statement of cash flows using either the direct method or indirect method. If the direct method was used, the indirect method was required to be shown as well. This requirement was eliminated. Many WNDE clients already do indirect method

REPORTING EXPIRATION OF CAPITAL RESTRICTIONS Eliminates the current over-time method for handling the expiration of restrictions on gifts used to purchased or build long-lived assets such as buildings. Nonprofits must use the placed in service approach in the absence of explicit donor stipulations to the contrary. In other words, nonprofits must reclassify these gifts as net assets without donor restrictions when the asset is placed in service, rather than over the asset s useful life. As a result, organizations won t be able to match the depreciation expense with the release of these restricted net assets unless stipulated by the donor.

2016-18 CASH FLOWS Update requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments in this Update do not provide a definition of restricted cash or restricted cash equivalents. Net increase in cash and cash equivalents, and restricted cash (added on face of cash flow statement)

2016-18 CASH FLOWS Disclosure example The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the statement of financial position that sum to the total of the same such amounts shown in the statement of cash flows. Cash and cash equivalents $1,465 Restricted cash 125 Restricted cash included in other long-term assets 75 Total cash, cash equivalents, and restricted cash shown in the statement of cash flows $1,665 Amounts included in restricted cash represent those required to be set aside by a contractual agreement with an insurer for the payment of specific workers compensation claims. Restricted cash included in other long-term assets on the statement of financial position represents amounts pledged as collateral for long-term financing arrangements as contractually required by a lender. The restriction will lapse when the related long-term debt is paid off.