LEASE ACCOUNTING CHANGES – AN OVERVIEW

NEFA Funding Symposium – October, 2016

  1. Accounting Guidance
  1. FASB 13 – original GAAP
  2. ASC840 – Accounting Standard Codification (new name, same FASB 13)
  3. ASC842 – New Rules (replaces ASC840)
  1. Overview of Changes – Classification Tests for lessor and lessee – looks familiar but without the “bright lines”! Classify as direct finance if any response is “yes” or operating if all responses are “no”.
  2. Transfer of ownership test – Does the lease transfer ownership of the underlying asset to the lessee by the end of the lease term?
  3. Lessee purchase option test – Does the lease grant the lessee a purchase option of the underlying asset that the lessee is reasonably certain to exercise?
  4. Lease term test - Is the lease term for a major part of the remaining economic useful life of the asset (if commencement date is at or near the end of the underlying asset’s economic life, this test does not apply)?
  5. Present value test – Does the present value of the sum of (1) lease payments and (2) lessee residual value guarantee not reflected in the lease payments, equal or exceed substantially all of the underlying asset’s fair value?
  6. Alternative use test – Is the underlying asset of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term?

Using the bright line tests will be acceptable, but how will auditors interpret your 89,9% PV lease since the actual test criteria is “substantially all” and not an objective 90%?

  1. Lessors – accounting largely unchanged from current US GAAP
  2. Lease starts the date the client has physical possession – interim period is included in lease term and interim rent is considered a part of the lease stream (including for purposes of the classification test)
  3. Take into account the likelihood of renewal options when determining lease term
  4. Updated definition of IDC (less cost will likely qualify for deferral)
  5. No differentiation between leases of real estate and other assets
  6. Sales type classification ignores third party residual guarantees (may result in lessor losing up front gross profit recognition in favor of larger return over the lease term)
  7. Sale leasebacks with purchase options will need careful review and structuring to avoid loss of sale treatment and operating lease treatment for lessee customers
  8. Leveraged leases will be grandfathered for lessors but leveraged lease accounting will not be allowed for new leases commencing after the transition date (impacts large ticket transactions)
  1. Lessee – more substantial accounting changes than the lessor
  2. Lessee obtains the right to use the underlying asset (ROU asset) in exchange for lease payments (lease liability)
  3. All leases other than short-term leases will be recognized on the balance sheet
  4. Presentation of interest expense in the income statement depends on lease classification (finance lease only)
  5. Lessee measures lease liability (and right-of-use asset) at the lease commencement date (the date on which the lessor makes the underlying asset available for use by the lessee. (currently lease inception date – the date the agreement is reached).
  1. Lessee – finance lease
  2. ROU asset = PV of lease payments + IDC (lessee’s) + prepaid lease payments – lease incentives received
  3. Amortized over the shorter of the lease term or useful life of the ROU asset (amortization expense). Record interest expense as incurred. This accelerates expensefor the lessee as interest expense will be front-loaded.
  1. Lessee-operating lease
  2. ROU asset = PV of lease payments + IDC (lessee’s) + prepaid lease payments – lease incentives received – same as finance lease
  3. Expensed straight line over lease term.
  1. Subsequent measurement – required to reassess classification if:
  2. the lease is modified and that modification is not accounted for as a separate contract
  3. There is a change in:
  4. The assessment of the lease term
  5. The assessment of a purchase option exercise
  6. The amount probable of being owed under a RVG
  7. A contingency is resolved resulting in some or all variable lease payments becoming fixed payments
  1. Lease and non-lease components need to be identified separately and recorded separately
  2. Examples of non-lease components
  3. Providing consumables
  4. Equipment maintenance
  5. Operations services
  6. If there isn’t an observable stand alone price for non-lease components you will need to estimate
  7. If a lease is reassessed during the lease term, there needs to be a remeasure and reallocation of the consideration in the contract
  8. Lessee can elect to combine as a single lease component
  1. Effective Dates
  1. Publicly held companies – Fiscal years starting after December 15, 2018 (calendar 2019)
  2. Privately held companies –Fiscal years starting after December 15, 2019 (calendar 2020)
  3. Early adoption is permitted
  1. Transition Rules
  1. Lessor – Modified Retrospective Approach – For all leases that exist at or after the earliest comparative period presented, apply ASC 840 (old rules) during the comparative period (prior year(s)) unless:
  1. The lease is modified during the comparative period(s)
  2. There is a change in classification (eg sales-type under ASC 840 to operating under ASC 842)
  1. Lessee – Modified Retrospective Approach –
  1. On effective date, record all leases on balance sheet that exist at or after the earliest comparative period present –
  2. ROU asset
  3. Lease liability
  4. Write off any IDC that would not have qualified for capitalization under ASC842
  5. Apply the new guidance to determine the classification of the lease under ASC 842.
  6. Recognize cumulative effect as an adjustment to opening retained earnings of earliest comparative period presented
  7. Single year financial will adjust beginning balances to retained earnings and move forward with new accounting method
  1. Either lessor or lessee may elect practical expedients as a means of simplifying the transition of existing transactions – two separate elections but all aspects of a particular practical expedient must be applied and they are applied to all transactions – no selective application
  2. Election ASC 842-10-65-1(f) – Previous conclusions
  1. No need to reassess whether any expired or existing contracts are or contain leases
  2. No need to reassess lease classification
  3. No need to reassess initial direct costs
  4. Election ASC 842-10-65-1(g) - Hindsight
  5. Use hindsight in determining lease term and impairment of ROU asset

Marci Slagle, CLFP, VFI Corporate Finance

Bruce Winter, CLFP, FSG Capital, Inc.

Nancy Geary, CPA, CLFP, ECS Financial Services, Inc.