Operationalizing Lease Accounting Accounting, Legal & Financing Perspectives

Transcription

1 Operationalizing Lease Accounting Accounting, Legal & Financing Perspectives Presented by December 4, 2018 TO RECEIVE CPE CREDIT Individuals Participate in entire webinar Answer polls when they are provided Groups Group leader is the person who registered & logged on to the webinar Answer polls when they are provided Complete group attendance form Group leader sign bottom of form Submit group attendance form to within 24 hours of webinar If all eligibility requirements are met, each participant will be ed their CPE certificate within 15 business days of webinar 1

2 Your Panelists Kevin Gore, CPA Partner Jenna Magan Partner Katie Proux Associate Rob Haight, CPA Director Mayling Leong Senior Associate Jay Miele Managing Director Today s Topics Review of ASU from accounting & technical perspective Compliance with financial covenants in legal documents Strategies for health care leaders in navigating the new lease accounting changes 2

3 Review of ASU FASB s Reason for New Standard More faithful representation of an organization s leasing activities SEC largest form of off-balance-sheet financing 2005 SEC estimate $1.25 trillion off-balance-sheet operating lease commitments for SEC registrants 3

4 Effective Dates ASC 842 Public Entities Annual & interim reporting periods beginning after December 15, 2018 All Others Annual reporting periods beginning after December 15, 2019 Public entities (PEs) include conduit debt obligors Applies to interim periods in fiscal year of adoption for PEs Not applicable to GASB reporting entities (see GASB 87) Determining Whether a Lease Exists Identified Asset Explicitly or implicitly specified Not able to substitute Right to Control Decision-making authority Substantially all the economic benefits Lease 4

5 Identified Asset A leased asset must be specifically identifiable as either Explicitly, e.g., by a serial number Implicitly, e.g., the only asset that would satisfy the lease contract Supplier does not have practical ability to substitute alternative asset, e.g., customer can prevent substitution Supplier would not benefit from substituting alternative asset A physically distinct portion of a larger asset could represent a specified asset, e.g., one floor of a building. A capacity portion of a larger asset generally is not a specified asset, e.g., percentage of a storage tank Right to Control Use of the Asset A lease contract conveys the right to control use of the identified asset for a specified period of time. A customer controls an identified asset when the customer has both of the following Right to direct its use The right to direct how & for what purpose the asset is used, including the right to change how & for what purpose the asset is used Right to obtain substantially all economic benefits from its use By having exclusive use of the asset throughout the period 5

6 Short-Term Leases Leases, at commencement date, have a term of <12 months & do not include option to purchase underlying asset that the lessee is reasonably certain to exercise This policy election must be disclosed in the financial statements Entities can make a formal policy election to not recognize short-term leases on the balance sheet Related-Party Leases Old Guidance ASC 840 Used substance over form in evaluating the existence of a lease New Guidance ASC 842 Use the legally enforceable terms & conditions of the agreement In the separate financial statements of the related parties, the classification & accounting for the leases should be the same as for leases between unrelated parties 6

7 Contracts with Multiple Components Lease Component A separate right to use an asset Lessee can benefit from the right of use of the underlying asset either on its own or together with other readily available resources. The use is neither highly dependent on nor interrelated with other assets Payments accounted for as a separate lease Nonlease Component An activity that transfers a separate good or service to the customer Includes maintenance services Allocated payments are nonlease period expense Not a Separate Component Related to administrative tasks to initiate the lease & payment of lessor costs that do not transfer a separate good or service separate from the ROU asset Includes payments for insurance or property taxes Payments are part of lease payment, not separately allocated Lease Classification How to determine the accounting for your lease Bright-line tests are not required; can be used as a reasonable approach Lease will be classified as finance lease if it transfers substantially all risks & rewards of ownership (meets one of the five criteria on the next page) All other leases will be classified as operating leases 7

8 Finance Lease Criteria (Similar to Today s Capital Lease) Ownership of asset transfers to lessee by end of lease term Lessee has purchase option that it is reasonably certain to be exercised Lease term is for major part of economic life of asset (n/a for leases that commence at or near the end of the underlying asset s economic life, e.g., in the final 25% of an asset s economic life) PV of minimum lease payments amounts to at least substantially all of fair value of leased asset NEW: underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term Lessee Accounting Initial Measurement Lease liability (obligation to make lease payments) Measured at the present value of the future lease payments Right-of-use asset ROU asset = lease liability + initial direct cost + lease prepayments - lease incentives received Amount initially recorded as a ROU asset; lease liability is computed the same regardless of whether the lease is classified as an operating lease or a finance lease 8

9 Lessee Model Subsequent Accounting Annual expense recognition & subsequent amortization of ROU asset depends on lease classification Finance lease Front-loaded expense pattern similar to today s capital leases with interest & amortization recognized separately Interest determined on the lease liability in each period during the lease term as the amount that produces a constant periodic discount rate ROU asset generally amortized on a straight-line basis Operating lease Straight-line expense recognition similar to today s operating leases ROU asset: reduced by the difference between the lease expense & the interest cost on the lease liability Comparison of Lessee Accounting Models Finance Lease Balance sheet Right-of-use (ROU) asset Lease liability Income statement Interest expense (on lease liability) Amortization expense (on ROU asset) Cash flow Cash paid for principal payments (financing activities) Cash paid for interest payments & for variable lease payments (operating activities) Operating Lease Balance sheet Right-of-use (ROU) asset Lease liability Income statement Lease/rent expense (straight-line) Cash flow Cash paid for lease payments (generally operating) 9

10 Lessee Balance- Sheet Presentation Disclosure Objective Help enable users of financial statements to assess amount, timing & uncertainty of cash flows arising from leases Significant assumptions discount rate, etc. Quantitative disclosure examples Financing lease costs Operating lease costs Short-term lease costs Variable lease costs 10

11 Transition ASU As issued Transition Timing ASC 842 Cumulative catch-up at beginning of the year ASC 842 ASU Optional transition relief ASC 840 ASC 842 Cumulative catch-up at beginning of the year Optional Relief Optional Relief Transition Elections Expedient package identification, classification, initial direct costs Hindsight Land easements Prior-period presentation Accounting Policy Elections Separation of lease & nonlease components for both lessee & lessor Portfolio approach Short-term leases Materiality thresholds (capitalization policy) Discount rate (non-pbes only) Presentation of taxes 11

12 Practical Expedients Short-Term Leases Leases with a term 12 months may apply current operating lease accounting If elected, must be applied to all leases within that asset class Still subject to qualitative & quantitative disclosures Portfolio Approach Aspects of ASC 842 may be applied at a portfolio level, e.g., determination of discount rate & lease term Must be a reasonable expectation that the portfolio approach is not materially different than application to individual leases Separation of Lease/Nonlease Components Lessees & lessors can make an accounting policy election by asset class to not assess separate nonlease & associated lease components Disclosures required if elected Impact on Client: Accounting & Reporting Policies Processes Controls Inventory & assessment of all agreements/contracts Significantly amend accounting policies & procedures Ongoing remeasurement requirements, e.g., index or rate changes, modification to contract terms, lessee s assessment of options to extend or terminate or purchase underlying asset Increased disclosure requirements Definitions requiring management s judgment, e.g., definition of lease, lease term, terminology, e.g., insignificant, reasonably certain, substantially all & book vs. tax differences Internal control changes with policy & process changes 12

13 Impact on Client: Information Systems System requirements Separate record-keeping for lease & nonlease components Triggering of reassessment criteria Maintain financial reporting & SOX 404 risk at acceptable level Data retention & security; audit trails for lease classification & changes Support management s buy vs. lease/sale-leaseback decisions; lease negotiations Support management s financial statement forecasting & budgeting requirements, e.g., anticipated changes in ROA & EBITDA calculations Health Care Industry Agreements to Consider Automated medication dispensing machines (Pyxis, Omnicell, etc.) Free assets accompanying requirement to use vendor disposable Related-party real estate agreements Intercompany agreements Usage-based agreements (radiology, equipment, etc.) Physician office buildings & clinics 13

14 Compliance with Financial Covenants in Legal Documents Where Are the Financial Covenants? Any borrowing agreement associated with bonds, loans, credit facilities & other types of debt Common examples Master trust indenture Loan agreement Continuing covenant agreement Any debt, whether publicly issued or privately placed with a lender, generally has financial covenants requiring the borrower to meet certain financial ratios. If the borrower violates any of these covenants, this could trigger a default 14

15 Types of Financial Covenants Affected by ASU Debt or indebtedness as a component Balance-sheet line items as components Types of Financial Covenants Affected by ASU Debt or indebtedness as a component Rate covenant or debt service coverage test Borrower agrees to manage its business in a manner that is compliant with a stated ratio Net income: annual debt service Net income: maximum annual debt service Additional debt test Borrower agrees not to incur additional debt unless certain debt service coverage or financial metrics are met Whether ASU will have an impact on these covenants & ultimately compliance with them, may depend on how the borrowing documents define debt or indebtedness 15

16 Debt or Indebtedness as a Component Any obligation of the borrower for (a) repayment of borrowed money, (b) with respect to finance leases or (c) under installment sale agreements Why a covenant with this definition may not be affected by ASU Debt is confined to specific categories that do not include operating leases ASU term used: finance lease Debt or Indebtedness as a Component Any indebtedness or obligation of the borrower, as determined in accordance with GAAP, including obligations under conditional sales contracts, & rental obligations under leases which are required to be capitalized on the balance sheet under GAAP Why a covenant with this definition may be affected by ASU Dependent on whether GAAP treats operating leases as debt Operating leases will be capitalized on the balance sheet under ASU

17 Debt or Indebtedness as a Component If definition of debt or indebtedness would include operating leases under ASU Provision that allows computation under borrowing document to be in accordance with GAAP in effect on the date of delivery of the borrowing document Includes determination of the character or amount of any asset, liability or item of income or expense Usually found in interpretation section Drafting consideration for amendments or future borrowing documents Specifically exclude operating leases from definition of debt or indebtedness Fun A Fact provision goes that allows the calculation here and draws of a financial ratio in special accordance attention with GAAP to the in effect slide on the highlight. date of the borrowing document can mitigate the effect of a broad definition of debt or indebtedness Types of Financial Covenants Affected by ASU Balance-sheet items as components Examples Current assets: current liabilities Total liabilities: total liabilities + net assets Long-term indebtedness: long-term indebtedness + unrestricted net assets 17

18 Mitigating Risk of Covenant Default Review financial covenants in borrowing agreements to determine if ASU will affect compliance Key assessments Assess whether borrowing documents allow calculations in accordance with GAAP in effect on date of delivery of document Assess if balance sheet-based covenants are adversely impacted Assess if operating leases are considered debt or indebtedness If risk of default, assess amending borrowing documents If operating leases are considered debt, every time an operating lease is entered into, additional debt test has to be met Amendments to Borrowing Documents For privately placed debt, negotiate with lender Discuss with financial advisor what changes can be negotiated with lender to help ensure compliance with financial covenants If publicly held debt, consent of majority in principal amount of holders may be required A more feasible strategy may include redeeming the debt Other considerations for tax-exempt debt Amendments must be assessed with bond counsel to confirm no adverse tax impact; issuer involvement will be required 18

19 Strategies for Health Care Leaders Key Strategies Review financial covenants Communicate with lenders Language to exclude operating leases Analyze financial statement impact Heighten transparency in disclosure While the impact of the new lease accounting standard will vary by organization, there are several strategies health care leaders can implement now to mitigate their risk 19

20 Key Strategies Review financial covenants Communicate with lenders Language to exclude operating leases Analyze financial statement impact Heighten transparency in disclosure Carefully review financial covenants in existing borrowing agreements before the lease accounting change goes into effect Definition of indebtedness Covenant calculations requirements Ability to continue covenant calculations under GAAP prior to lease accounting change Key Strategies Review financial covenants Communicate with lenders Language to exclude operating leases Analyze financial statement impact Heighten transparency in disclosure Talk with lenders regarding their interpretation of the lease accounting guidance & any amendments Is the debt privately placed or publicly offered? Potential to amend existing debt to clarify how leases are accounted for in covenant calculations 20

21 Key Strategies Review financial covenants Communicate with lenders Language to exclude operating leases Analyze financial statement impact Heighten transparency in disclosure Include language that calls for exclusion of operating leases from the definition of debt in all new borrowings before & after implementation of the new lease accounting standard New borrowing agreements should incorporate language that addresses leases Key Strategies Review financial covenants Communicate with lenders Language to exclude operating leases Analyze financial statement impact Heighten transparency in disclosure Complete a financial statement impact analysis in advance of making lease-vs.-buy decisions Why pursue monetization? Generate cash for reinvestment into business or to build balance-sheet strength Provide flexibility to vacate or renew leases in the future, depending on preference Maintain desired control of assets through lease provisions Financial statement considerations Impact on depreciation Any gain or loss on sale of the asset Amortization of a new capital lease payment Increase of long-term debt or long-term liabilities & corresponding adjustment to right-of-use asset 21

22 Key Strategies Heighten transparency in disclosure to investors Review financial covenants Communicate with lenders Language to exclude operating leases Analyze financial statement impact Heighten transparency in disclosure Disclose when new guidance is being adopted Include notes in the management discussion & analysis section of the audit, disclosing lease details Highlight any material impact to financial statements anticipated when the change is adopted New public debt offering Borrower may need to have the impact flushed through its internal financials before year-end If issuing a new public debt offering with stub financials, it s possible the new lease accounting standard will need to be applied if the standard is in effect during the fiscal year when the new debt is issued 22

23 Continuing Professional Education (CPE) Credit BKD, LLP is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: CPE Credit CPE credit may be awarded upon verification of participant attendance For questions, concerns or comments regarding CPE credit, please the BKD Learning & Development Department at training@bkd.com 23

24 The information contained in these slides is presented by professionals for your information only & is not to be considered as legal advice. Applying specific information to your situation requires careful consideration of facts & circumstances. Consult your BKD advisor or legal counsel before acting on any matters covered 24