New Lease Accounting: Top 10 FAQs Surrounding ASC 842

https://www.wipfli.com/insights/articles/aa-new-lease-accounting-faqs-surrounding-asc-842?_cldee=aGtvdHVsYUBtc2hvc3Aub3Jn&recipientid=contact-3fde72f1ca28e911a97a000d3a16a9e6-9d947a3bfa4e4003b7370949b112a3ee&utm_source=ClickDimensions&utm_medium=email&utm_campaign=Accounting%20Wire%20newsletter&esid=222a6d3a-f24f-e911-a980-000d3a16acee

Image result for (ASU) No. 2016-02, Leases (ASC 842)

What seemed like a topic that was always in the distant future is now upon us: accounting standards update (ASU) No. 2016-02, Leases(ASC 842). 

Under previous rules, lessees typically accounted for lease transactions as off-balance sheet operating leases or on-balance sheet finance leases. Under the new standard, lessees will have to recognize nearly all leases on the balance sheet. 

ASU 2016-02 comes on the heels of Revenue Recognition (ASC 606) and presents another wide-reaching and major change to the accounting world. Under ASU 2016-02, balance sheets will swell as nearly all leases will now be capitalized. Overall the ASU is very complex; however, below are some frequently asked questions that we are seeing from our clients and the industry. Like most things, the devil is in the details, but the below Q&A can provide high-level answers to these burning questions.

1. When is the standard effective?

ASU 2016-02 is effective for public companies in 2019 and private companies in 2020.

2. What are the changes to how capital leases (now known as “finance leases”) are presented?

The general accounting for finance leases remains largely unchanged compared to the legacy presentation of capital leases.

On the balance sheet, the finance leased asset is typically recorded as part of property, plant and equipment (PP&E), and the lease liability is recorded as funded debt. From a profit and loss perspective, the leased asset is depreciated over the shorter of the term or asset’s useful life, and interest expense is front-loaded as the lease obligation is amortized.

3. How will operating leases now “look” on the balance sheet?

Operating leases take on an entirely new look under ASC 842 in that a right-of-use (ROU) asset and liability are recorded by calculating the present value (PV) of the lease payments using the appropriate discount rate.

Balance sheet presentation of a ROU asset is classified as a long-term asset on a separate line item outside of PP&E. Furthermore, the ROU lease obligation will need to be separated into short-term and long-term liabilities that are aside from funded debt. The profit and loss components of a ROU asset and corresponding liability are amortized under the straight-line method and presented together as rent or lease expense.

Under ASC 842, neither amortization of the ROU obligation nor the ROU asset is considered interest expense or depreciation expense, leaving EBITDA unchanged from accounting for operating leases under the prior lease standards. 

4. Does the standard change the way we determine which type of lease we have?

There will continue to be two types of leases: finance (formerly known as capital) and operating. However, both will require recognition of an asset and a liability on the balance sheet. The differentiation between the two types of leases will play a significant role as to balance sheet classification but does not come without significant analysis in determining what type of lease it actually is.

Finance leases will no longer be evaluated using the “bright-line” tests. Rather, they will be evaluated using principles-based criteria, which aim to evaluate the underlying substance of the lease. The principles-based criteria certainly involve a level of subjectivity; however, the finance lease classification applies should any of the following be met:

  • The property transfers to the lessee at the end of the lease.
  • The lessee is reasonably certain to exercise a purchase option.
  • The lease term is for a “major” part of the asset’s economic life.
  • The present value of lease payments equals or exceeds “substantially all” of the fair value of the asset (undoubtedly the most subjective — more on this later).

If the lease does not meet the above criteria, it will be considered an operating lease. 

5. What changes for lessors vs. lessees?

From the lessor’s point of view, not much changes. In contrast, lessees will now be required to capitalize all leases with terms greater than 12 months.

6. Why is the FASB doing this?

Think about this: Prior to this standard, airlines had not been recording their airplanes on their balance sheets! The standard provides better clarity to users of the financial statements via recognition and measurement of a company’s leased assets and associated liabilities that have historically been tucked away in a footnote disclosure.

7. How do I determine the discount rate?

This is where things can get tricky! To determine the PV, lessees should use the implied rate in the lease contract (if known) or the company’s incremental borrowing rate. This rate is based on what rate the company would obtain if financing 100% of the underlying asset using similar terms and pledging the asset as collateral. 

Knowing that this is often difficult to determine, private companies are afforded an election to use the risk-free rate (e.g., Treasury bill). However, this comes with caution as it typically results in a higher PV, leading to a larger corresponding asset and liability to be booked.

8. Are there new disclosures required?

The footnote disclosure under current standards doesn’t afford financial statement users with many details on either type of lease; however, this is changing. Under ASC 842, the disclosure will provide the reader with both quantitative and qualitative information as to how the lease classification was determined. This information will help the reader comprehend significant judgments and assumptions that were used in evaluating leases under the principles-based criteria.

9. How will this impact my loan covenants?

With operating leases now on the balance sheet, various financial metrics, including those commonly used in loan covenants, are sure to change. The measures of working capital, quick ratio, current ratio and any metrics related to debt (i.e., funded debt) will need to be reviewed carefully to understand how newly capitalized leases will influence results.

In calculations involving EBITDA, the change should not impact results as interest and depreciation (associated with finance leases) are added back, and operating leases (presented as rent or lease expense) are commonly excluded from the benchmark.

Needless to say, it will be imperative to be proactive with your banker. Covenants should be analyzed to determine the impact of the new standard. Some lenders are changing agreements to use updated metrics, while some are simply adding wording to the covenant calculation that says, “Under GAAP in place as of the date of this agreement.” That may seem to simplify things; however, it may also require you to keep two sets of books and records, which can get complicated.

10. How do I prepare for these changes?

The first step is to digest the change in standards and the ripple effect that will come from capitalizing substantially all leases. This will involve an evaluation of the appropriateness of systems, procedures and controls necessary to accumulate and track pertinent lease information. Determination will need to be made as to adoption of ASC 842, which is available on a modified retrospective basis or through a cumulative effect adjustment as of the beginning of the year of adjustment.

A proactive approach to the change in lease accounting is certain to help reduce the burden and headaches of another significant change in accounting standards. If you haven’t done so already, you should start your process in a variety of ways, including knowledge transfer sessions, the evaluation of lease contracts and interpreting the impacts on financial statement presentation and disclosures.

 

 

Alexa, What Is Blockchain?

https://www.wipfli.com/insights/articles/aa_alexa-what-is-blockchain?_cldee=aGtvdHVsYUBtc2hvc3Aub3Jn&recipientid=contact-3fde72f1ca28e911a97a000d3a16a9e6-9d947a3bfa4e4003b7370949b112a3ee&utm_source=ClickDimensions&utm_medium=email&utm_campaign=Accounting%20Wire%20newsletter&esid=222a6d3a-f24f-e911-a980-000d3a16acee

Image result for blockchain

The last few years have seen a rise in technologies that promise to change the world as we know it. Blockchain is one of the technologies at the center of this universe. We’ve seen headlines like, “Audit dead in a decade?”, “Blockchain isn’t so bad …,” and “Blockchain will start to become boring.” Blockchain is going to change how business is conducted today and into the future, just like any other business application. The billion-dollar questions are how and when. Let’s start with blockchain fundamentals.

Fundamentals

Blockchain, as most know it, is a public, decentralized distributed ledger that can store and confirm all transactions recorded to the ledger. Wait, what? Let’s break down that sentence into what it means to you and my mother. Public simply means available for anyone to use. Decentralized means reducing the power any one party may have over the other and in the end being less likely to find our data being at the mercy of a single institution. Distributed ledger is the avenue used to store and share valuable data and could be anything from a home deed to digital currency.

Public vs. Private

Many think of blockchain transactions as being available to the public, similar to bitcoin. But what happens when I transfer my bitcoin to a public exchange, conduct business on that exchange and withdraw my bitcoin? The business that was conducted on the exchange is not public information, just like stock trades in your brokerage account.

Blockchain provides the opportunity for public and private ledgers to work together and provide the best of both worlds. Imagine paying your employees through blockchain, whereby the transactions are recorded within your private general ledger, and the payroll taxes, retirement funds, and health insurance information are recorded within a consortium (hybrid) ledger. In a case like this, only invited parties would have access to participate in respective ledgers, and then payments would be remitted on a public ledger in the form of bitcoin to those respective vendors.

What Happens to Your Auditors?

I’ve seen the headlines, read the articles and contemplated my career when they say, “Your job will be gone in five years.” Here is a direct quote from an accounting professor: “The distributed ledger reduces the need for audit by 97%. Audits in the future will be competed on the basis of productivity, which will essentially mean who has the fastest hardware and software. And fraud, in the classical sense, will be all but impossible.”

Wow, our professor has overestimated that everyone and every business will be on a gigantic, public, decentralized distributed ledger where anything is possible! That would require an unbelievable amount of trust in a system in less than 10 years that leads to everything being verifiable. I’m not ready to hand over all of my data to a decentralized system where my cash inflows and outflows, including my daily coffee habits, are public knowledge. Are you?

For blockchains to eliminate auditors, there must be a problem within the current state according to the public, a return on investment for the investor and commitment to 100% adoption by all companies. Audits will continue to evolve, as they have over the last several years; that is a statement you cannot argue with. However, the assumption that all transactions are recorded, categorized correctly and authorized is why accounting professionals are still needed. For example, the argument that you didn’t pay your taxes because you were unaware of your obligation doesn’t fly with the IRS; ignorance in this case will be no different.

Data analytics is a great example of a similar “game changer” that has been discussed and highly touted over the last 5-10 years. While some companies have jumped on board, many others are still hesitant to employ these strategies. Similarly, ask lawyers their thoughts on LegalZoom, which first started offering legal service products to the public in 2001. The last time I checked, lawyers haven’t disappeared, right? In fact, a counterargument could be made that they are doing more work than before LegalZoom to help correct their client’s intentions. In other words, blockchain will change how business is conducted; however, it will not be perfect and will not be nearly as fast as many are implying.

This implementation timeline is another concept that many are not fully aware of. There are some significant barriers to overcome, the largest being the sheer computing capability necessary for blockchain to operate effectively. People mine bitcoin, and it takes weeks to make a coin. The more secure the “chain,” the longer it takes to register something on the ledger. That makes sense, right? If the lock is more complex, it will take longer to open it. Currently, without quantum computing, it would take over 100% of the electrical grid capacity to power the computers to do everything blockchain promises to accomplish.

Three Areas Where Blockchain May Make Your Life Easier in the Future

  1. Cash: Bitcoin and others may or may not be the answer to a lot of problems within our current system; however, when you break it down into the simplistic view that it is utilized by independent companies as a secure way of transacting business with nearly instant settlement in comparison with the current banking system, the possibilities start to expand. That is one of the reasons a large bank such as JPM is coming out with its own coin or Fidelity with its own crypto exchange, both in 2019.
  2. Smart Contracts: Why so smart? Smart contracts allow entities to connect multiple inputs to prove contractual obligations are met. Upon those obligations being met, payment would be disbursed and recorded to other blockchains. Put another way, smart contracts in their simplest form are decentralized automation that facilitate, verify and enforce the performance of a transaction. To provide a simple example, a company ships a product to a customer; however, the funds will not be released until the tracking information shows that the product was delivered to the customer.
  3. Supply Chain Management: Wal-Mart is one of the largest and most well-known examples in blockchain supply management, which will soon require lettuce and spinach suppliers to utilize their blockchain database, which will allow rapid location of the source of any contamination. Now let’s take it a step further: Consumers can scan a code from their phone to see the origins of that spinach, including when it was picked. Now imagine that instead of tracking just spinach, you’re able to track the ingredients of your pasta sauce using the same app on your phone. Blockchain will allow large amounts of data to interact with end users in a way we’ve never seen before, and that will only continue to evolve year over year.

In summary, blockchain will change the general concept of how we think of accountants. As routing tasks are automated, the role of accountants will become more and more focused on advisory and analysis, rather than traditional “ticking and tying.”

The burning question is when. Depending on who you ask, you may get a very different timeline, so what is the answer? Generally speaking, we overestimate the amount of technological change that is going to occur in the next 2-5 years, and we underestimate the amount of technological change that is going to occur in the next 10-20 years. Blockchain is no different. Stay tuned.

 

The CFO Confidence Crisis

https://www.kornferry.com/institute/CFO-succession-plan?mkt_tok=eyJpIjoiTlRJM09UWmxNREpqT1RGaSIsInQiOiJMcEhLaTZabUw0N1QxcTN3OUlqWVA4eldPcG1XRlwvWXJzbzVnM3c1M1JUYkNuRGhvTWFQTG9PenhJbnByOXkwcitLazlkbTh1UTBKQzEwRmx5YmMwZE9aWU1Hb0ZhdTkwVUp1RGhOUTJSNDU4UVpzcFZVSm9mVjE3K1NNTWkrNHIifQ%3D%3D

Few roles are as important as the chief financial officer at most companies, but the CFOs today who are thinking about tomorrow are growing nervous about a key talent issue. They just don’t think anyone else in the company can assume their role.

Indeed, according to a new Korn Ferry survey, 81% of CFOs surveyed say they want to groom the next CFO internally, but they don’t believe that there’s a viable candidate in-house. Currently, about half of new roles are filled internally. 

“The current CFO is the one charged with identifying and developing that talent, and since they know best the skills required to meet what’s coming, they are realizing the internal bench isn’t fully prepared,” says Bryan Proctor, senior client partner and Global Financial Officers practice lead at Korn Ferry.

The lack of confidence is owed in part to CFOs feeling that their firms’ leadership development programs haven’t kept up with the rapidly changing role of CFO. Core functions such as finance and accounting are increasingly being combined under one role, with CFOs citing a lack of resources or skills and career development opportunities as reasons for the merging. Korn Ferry surveyed more than 700 CFOs worldwide, asking them about their own internal talent pipelines. The top two abilities CFOs feel their direct reports need to develop are “leadership skills and executive presence” and “strategic thinking.” 

“The tapestry of skills and experiences CFOs of today and tomorrow need are vastly different than what was needed in the past,” says John Petzold, senior client partner and CXO Optimization lead at Korn Ferry. “The reason subfunctions are merging is because the focus is less on a role or person and more about the capabilities that need to be covered by a set of individuals.”

In essence, the CFO function is being deconstructed for optimization. Leaders are breaking down necessary functions based on their organization’s strategy and identifying people with a combination of those skills and piecing them together to get the right set of talent to execute against that plan. Core financial functions such as taxes, capital allocation, and M&A still need to be done accurately and in compliance with regulations, of course. But experts say the CFO role is becoming more about adapting and deploying talent in the most efficient manner possible. 

“The leadership profile of the future CFO is less about tactical, direct experience, and more about learning agility, adaptability, and big-picture global perspective,” says Proctor. “That kind of nimbleness and ability to pivot isn’t naturally ingrained in the typical CPA.”