Connect with Ane: https://www.linkedin.com/in/aneohm/
LeaseCrunch Website: www.leasecrunch.com
What is ASC 824? The ultimate guide: https://www.leasecrunch.com/blog/asc-842
5 FAQs about embedded leases: https://www.leasecrunch.com/blog/embedded-leases
Request a demo: www.leasecrunch.com/request-a-demo

Full Episode Transcript:

[00:00:00] < Intro >

 

Adam:            Welcome back to Count Me In. The podcast for accounting and finance professionals working in business. I'm Adam Larson. Today we'll be discussing a perennial hot topic lease accounting, specifically, FASB's new standards for private companies and nonprofits under ASC 842. And just in case you're unaware, the deadline to transition to the new standards is December 31st, 2022.

 

Thankfully, I'm joined, today, by a true expert in this, infamously, thorny topic. Ane Ohm, is a CPA as well as co-founder and CEO of LeaseCrunch, a software company that helps companies simplify their lease accounting. If you're looking for practical tips and best practices to make lease accounting a little less stressful, this is the conversation for you. Let's get started. 

 

 

Well, Ane, I want to thank you so much for coming on the podcast, today. We are going to be talking about lease accounting. And as all of us know that the standard, the new Lease Accounting Standard deadline is approaching very quickly, and people should get started. We've been talking about this since what? 2018. And if you haven't gotten started the time now is to get started. What do you think? What is your advice to people as we start talking about this?

 

Ane:                I think the big thing with any accounting standard is that, and when I was running a different company. A new accounting standard would come up and I would ask my accountant, "What is the last moment I have to do anything about this?" And that's when I would do it. And the challenge with the lease accounting standard, if you wait there's a couple of things, first of all, leases can be complicated. 

 

And, so, that analysis of your lease, spending the time understanding it in the context of the new lease standard can take some time. And, secondly, if you need help and you wait the experts are going to be busy. So you're going to have a really difficult time getting a hold of someone who can really guide you through the right steps. 

 

So we're actually hearing CPA firms state that if their clients wait, they're going to have to charge them more in order to be able to offer that assistance. Because they're going to be so busy with other things. If you wait until January, February, this is going to be rough. So start now, get on top of it, it's just going to make things, life, better for you.

 

Adam:            Yes, for sure, because you don't want to wait till the last possible second because it's going to fall back in your face. Do you think that maybe we could start, in this podcast, to maybe go over some practical expectations and how to make your adoption easier? Especially if you are just getting started now, or even if you've been aware, you've been preparing. But to the actual practical application, it's still going to be a difficult process.

 

Ane:                Yes, so there's something to it when you think about the new Lease Standard, you have basically two types of leases. Leases that existed before the standards needed to be implemented, and then leases that start after the standard need to be implemented. So talking about those leases that started before your initial application date of the new standard. The FASB, Financial Accounting Standard Board really wanted to make sure that this was as easy as possible. It sounds like that might not be true, but it is, they have said that repeatedly. 

 

And, so, what they've done is they've actually provided some practical expedience and those practical expedience, the whole purpose of them is to simplify the new standard. So for those transition leases, those leases that existed before, if you have a nice software available to you, there's really only six pieces of information that you need to do. 

 

If you apply those practical expedience, make sure you're doing the things that make this as easy as possible. And then collect those six basic pieces of information. And those are; start date, well, guess what, that start date is going to be the initial application date of the standard. 

 

So if you know that already, huh! If your end is December 31st, that's going to be January 1st, of 2022. All right, so we got one. Second one is, "When does the lease end?" It can be a little more complicated because you have to not just say, "When do I stop paying? When is the initial end of the lease?" I have to, also, look at it and see, "What might I be reasonably certain to renew a term or might I be reasonably certain to terminate early?"

 

So you really have to look at what is the total lease term, including renewals, if you're reasonably certain. It's a high bar but you do have to look at it.

 

The third thing is discount rate. So, and I don't think we know this but those first two seem, they are pretty easy. And the discount rate is the FASB offers the ability to just use the risk-free rate. So that's great because that's publicly available. 

 

You don't have to really think about it too hard. Or the challenge with the risk-free rate is that it will tend to be lower, which means your lease liability will be higher. If you don't want that for larger leases, the FASB, also, more recently, allows us to decide your discount rate based on asset class. 

 

So you can say, "All right, for my office lease, which is a big lease, it's going to be big dollars, I'll spend the time to figure out the higher discount rate. And if I have vehicles or photocopiers, I'm just going to use the risk-free rate."

 

So that's a nice thing, so that's the third piece of information. Fourth one, is, hey, is this an operating lease or a finance lease? Well, once again, FASB says, "You know what, if you had an operating lease before it's an operating lease now. If you had a capital lease before it's a finance lease now."

 

So you can elect that practical expedient to just move forward, so that's the fourth one. Boom, you know, that one. Fifth thing is, what are any existing balances on your balance sheet as of that first date? 

 

All right, if you had an operating lease and you had some deferred rent and deferred rent balance, you want to make sure to include that balance. Because you've got to be able to get that off the books. And then finally, what are your remaining lease payments? So those six pieces of information, while that it takes a little bit of analysis, they're not too complicated. 

So when I say get started now, I also mean that getting started now it's not overwhelming, it's not hundreds of bits of information. And I think that's a big thing that people do, is they assume it's going to be so hard, it's just better to push it off.

 

Adam:            Yes, you get overwhelmed by whatever the task is and you never actually start it, and then it becomes even more overwhelming because you're behind. And that's practical application of just business in general, trying not to procrastinate, right?

 

Ane:                Which I have to say, I mean, I live that every day, "When do I have to do this?" It's just for this particular one, there's another reason why getting on top of this can be really important. And that is many private companies, the reason they follow GAAP accounting is because they have a bank loan. And if they have a bank loan, adding lease liabilities could cause them to be in violation of some of their debt covenants. 

 

Now, those debt covenants are changeable, but you have to get on top of it. So what we hear from banks, is banks are waiting for you to come to me and tell me, if you think you're going to be in violation. Well, in order to know that and know what those numbers are, again, getting started early makes a ton of sense. 

 

You can have conversations with your banks. Make sure to make adjustments so that you hit your December 31st financials. You don't end up with a debt covenant violation that you really didn't need to have. 

 

So that is another really important reason to get on top of this early, and pay attention to those practical expedience that the FASB offers to make it easier. I'm also somebody who loves to make things harder. Like, "I'm going to do it the real way, I don't need the shortcut." No, come on, in this particular case it really makes a ton of sense to pay attention to those opportunities.

 

Adam:            It does make a ton of sense and something that you spend a little bit of time on. And I think we might need to delve into a little bit more, are those discount rates made available by FASB. I feel like that's something that you're really going to have to adjust your formulas. Or if you're using a software, you're going to have to really adjust and really re-look at everything to make sure that you're following that properly.

 

Ane:                Yes, there's a couple of things around discount rates that are really important to just know upfront. One is, again, going back to those transition leases, the FASB allows you to either determine, so because a discount rate matters, the term, the length of the term. So if you are borrowing $100 and you borrow it for a day versus 10 years, you're going to pay a different rate. The longer it is you pay more.

 

So what you want to do is look at, you can decide do you want to use a discount rate for the remaining term, or do you want to use a risk discount rate for the original term of the lease? And you have to make that election for every lease. So you can't pick and choose, that is something you have to make for every lease. 

So that's just something to keep in mind, looking at the rates that are available to you. Do you want to go back to the term? So if it's a 10-year lease, but they only have a year left, do you use a one-year term or do you use a 10-year term?" So that's one thing. 

Second one is look at, consider materiality, and what's going to be the easiest approach to this? So what does that mean, for your more material leases, spend the time to figure out a discount rate that would be specific to. So the lease standard says you're supposed to use the rate implicit in the lease, if it's readily discernible. That is almost never readily discernible. 

 

So it's nice that they say it but it's just, kind of, a pipe dream. You just don't generally have all of the information that you need, in order to know the rate implicit in the lease from a lessee standpoint. 

 

So then you have to go look at it and say, "Okay, well, my discount rate needs to be, then, the collateralized borrowing rate that I would need, if I was to borrow money to buy this asset for this amount of time. What is that rate? Just inherently you can feel like, "Oh, my gosh, how the heck do I do that?" So it's going to take a little bit of time to figure out your discount rate, if you have to actually calculate it.

 

So you only want to do that for the assets that matter. You only want to do that for where it's material. So that might be your office lease, if you're adding a million dollars onto the books, you probably want to make sure that you make that as low as possible.

 

Adam:            Sure. 

 

Ane:                So using a higher discount rate is going to be a benefit. Whereas for those smaller leases, just take advantage of that practical expedient. Use the risk-free rate, the published rate out there, boom. Look it up, boom, you're done, it's going to be much easier to do. And, again, for those transition leases, as you are making the transition to the new standard, that rate would be the rate as of, if December is year-end, it's going to be the rate as of January 1st, 2022, so that's when you will identify that rate.

 

Adam:            I just need to verify something; you keep saying 2022, do you mean 2023 or is it the rate of January, 2022?

 

Ane:                This standard needs to be, so if you have a December 31st year end, you need to be implementing this standard for your December 31st, 2022 financials.

 

Adam:            Oh, okay.

 

Ane:                So if you haven't started now, that means you are going back to January and you're figuring everything out back to January. The reason why so few people have started is because the standard says you don't have to implement the standard for quarterly, for interim financials, in 2022. You only have to do it for year-end. On a go-forward basis, you'll have to do it for all of your financials, any financial that you publish. So we accountants are saying, "Yay, I don't have to do anything yet, because it's not until year end."

Adam:            Yes.

 

Ane:                Now, but the fact of the matter is you do have to go back to January 1st, and that is actually another practical expedient that is offered by the FASB. 

Which is, let's say you have comparative financial statements, you have two years that you publish every year. You do not have to restate prior years, so that's a good thing. 

 

So if you have '21 and '22 on your financial statements, you can just implement this - as of 2022. I think, I know of one situation, where someone went back and restated prior years. Almost everyone is like, "Whew, I'm not doing that. I don't care if they're not very comparative for one year, I'm not restating 2021 if I don't have to."

 

Adam:            For sure. All right, so there's another type of lease that I've heard about that I know that this, particular, implementation affects is called the Related-party Leases. Can we maybe talk about those a little bit, especially since it affects the smaller organizations?

 

Ane:                Absolutely, it's actually incredibly common for an organization. Let's say you have a factory, and they're some sort of manufacturer. It is a common practice to have the building that the manufacturing company operates out of, to be owned by a slightly different set of owners. 

 

So it could be a parent sold the business to a child and retains ownership of the building. Or it could be, I've seen opportunities where the executive leadership has an opportunity to buy out the building and this is just another income opportunity for them, another way to… that's from a compensation standpoint. 

 

So anything like that where there are transactions between two separate entities, but there's a strong relationship between them, you have to disclose that. So that's what's important about related parties. The second thing from a lease standpoint, that's important about related parties, is that it may not be very well documented.

 

So what do we pay it for? How long? How long are we going to be in this building? There may not be a lease. There may be a lease that goes on for a really long time. So there are so many different things that can happen with related party leases. And, so, people are asking a lot of questions, they're really nervous about their Related-party Leases. 

 

So the thing that's really important about this is that related party leases, for the new lease standard, you do not have to try to conjecture what might happen. You actually go to the legally enforceable provisions. If there is no lease, you might not have something legally, but what would be legally enforceable?

 

So what does that mean? If you have a written lease, you just look at those terms and you apply the new lease standard according to those terms. You don't have to think, "Well, we're never going to move, so this should go on for 50 years." And now you have this massive lease liability that really isn't the intent of the new lease standard, not at all, that is not the intent. 

 

So the fact of the matter is, for related party leases, you look at it and you say, "What is legally enforceable?" And that can change, people could decide to change their leases to ensure that they're not, and really the big thing is not overstating the lease liability, that's what we all care about. We don't want this huge liability that skews our books. And, so, the important piece of that is to remember who is the user of your financial statements. 

 

So, if it is, again, to go back to if it's the bank is the primary user of your financial statements, and they understand that related party relationship, and they understand how that's getting reflected onto the financial statements, that's what's most important. It's not just about complying with GAAP, it's that the users of the financial statements have a clear and transparent understanding of your business.

 

Adam:            Mm-hmm. So I know that when this was first enacted or talked about in 2018, it affected all of the public companies. So now it's affecting everybody, if you follow GAAP you have to do this. Now, let's say you're a small company, small organization, and you may only have one lease. You're like, "Oh, I don't need to do that, I just have one." That would be incorrect for you to think that way, correct?

 

Ane:                Yes, so in 2022 if you have to follow GAAP and you have even a single lease, this applies to you. And the thing that's important to remember about that single lease is it's oftentimes your office space. So it's a material lease, not just a couple of hundred dollars, but it's usually thousands and thousands of dollars, and would be material to your financial statements. 

 

So it really is important to make sure that you're paying attention to this. I remember one of the very early days I was doing a training. I was talking about all of this, going through a whole training about everything relating to this standard. And the first question was a guy in the back, he's like, "So, wait a second, does this apply to all of my leases? What about my vehicles? Well, what about my equipment?"

 

He just was sure that maybe it was just real estate. I'm like, "No, it is all leases. If it's a physical asset, it's all leases." So it has been, and we saw this for public companies, where maybe they just didn't pay as much attention to operating leases because they just expensed it. So it didn't really matter if they identified them when they started looking through all of the arrangements that they had. 

 

For example, hospitals, hospitals will use consumables. So let's say it's a thermometer, and the thermometer has a little plastic tip on that, this is back when they actually had to touch you, put it in your ear or on your forehead, so that that little plastic tip was a consumable. You need to dispose of it every single time. 

So companies would actually say, "Hey, if you buy all of those consumables from us, we'll throw the thermometer itself in and you don't have to pay extra for it. If you buy this much in consumables." Well, guess what, that thermometer actually becomes a lease.

 

Adam:            Wow.

 

Ane:                Yes, because it's a physical asset and you're using it for a period of time and you are compensating a company for it. So you got to pay attention to the physical assets that your organization is using. Very importantly, it doesn't have to be called a lease in order for it to be considered a lease under this new lease standard.

 

Adam:            So you really got to read the fine print and the rules, and see exactly what it is.

 

Ane:                Yes, so one of the things that, from a resources standpoint, to, for example, uncover situations like I just described. We actually have what we call an embedded lease identifier for free on our website. You go to our Resources page and the purpose of it is to help an organization understand is this contract, is this arrangement, is this agreement, is it possibly a lease? 

 

Is there possibly a lease in here? 

 

And you go through five questions and they're not easy. But it's just five questions, one at a time, with examples of yes versus no. And at the end you actually can have a report emailed to you that says, "Yes, this is a lease." Or "No, this is not a lease."

 

And for an organization, this can be a helpful audit tool to show their auditors, "Hey, we went through all of our arrangements." All these different reasons why, maybe I have a regular payment to a company and I just want to make sure that is this, or is this not actually a lease?

 

I've gone and I've done the consideration, and I know it's not a lease and it's okay that I don't apply the new lease standard to this. So the good news is there are resources out there, look at our website, leasecrunch.com, we have a lot of free tools, and guides, and educational materials to help people understand this standard. It's hard enough, leases are complicated. We don't need to make it harder than it has to be, so, we really want to try to ease that burden for everyone.

 

Adam:            Well, awesome. Well, and I'll make sure to have those links in our show notes. So my audience, please make sure you click those links. And, Ane, thank you so much for coming on and trying to break this complicated subject down for us today. I think we all have probably have a better understanding.

 

Ane:                My pleasure. Thank you very much for having me.

 

 

Announcer:    This has been Count Me In, IMA's podcast, providing you with the latest perspectives of thought leaders from the accounting and finance profession. If you like what you heard and you'd like to be counted in for more relevant accounting and finance education, visit IMA's website at www.imanet.org.