Navigating GASB 87 Lease Accounting

Hello and welcome to this webinar on GASB 87 and navigating the ins and outs of how to transition onto this new standard. I'm Adam Riches and I am one of the partners here at NetGain. We've been around for about two years and before that I was at NetSuite. I worked directly for NetSuite in the finance center of Excellence focusing on all things accounting and finance. I was a controller for a couple of public companies here in the Denver area and then I started out my career as an auditor. So. So it is great to be on with you today to talk about lease accounting.

Hi, this is Nathan Smart. I also started my career in public accounting at one of the big four accounting firms. Spent a couple years closing the books for a large not for profit hospital group. And then I spent close to a decade doing management consulting at one of the top management consulting firms. So excited to talk about lease accounting. We're really passionate about bounce topic.

Thank you. And so just a little bit before we get into the lease accounting topic, I wanted to highlight about, you know, who, who we are, what net gain is. And so we, we develop solutions on the NetSuite platform. We have our lease accounting solution which is really what supports the process we're about to talk about today. We have a lessor solution which is the flip side of that coin that manages lessor accounting. We have an asset solution that can take on some advanced fixed asset accounting requirements including you know, tax, tax reporting and, and some units of production or some intercompany markups and things like that that take place on, for your asset records. And then we have loan which really tracks the principal and interest breakout on the accounting side. But really we're here and we're continuing to expand our product suite. We really are here to build products that simplify, standardize and, and automate these complex accounting processes. So again we're grateful to have you on and excited to talk more about lease accounting. We wanted to touch on the evolution, how we got to GASB 87 and what events kind of transpired leading up to it, the adoption dates and things that are impacting that right now. And then also the COVID impact. There's been a lot of renegotiations going on. I want to talk about exactly what the GASB is doing about that and how they're trying to help make that process a little easier. Then we're going to talk about accounting under GASB 87 transitioning onto the new standard and then how you can automate it and of course, we want to leave time at the end for some Q and A. So without further ado, we'll jump right into the evolution of lease accounting and.

Lease accounting as we know it really dates back 40 plus years ago. Back in the 1970s is when the FASB was asked by the SEC to establish a guidance on accounting for leases. The International Accounting Standards Committee followed up shortly thereafter. And then 1990 is when GASB issued statement 13. All three of those were roughly the same in the sense that they created this bright line determination between whether an asset was in subs or whether a lease agreement was in substance, a financing arrangement to purchase an asset or whether it was a rental of that asset. And so there were the four criteria that. And if you triggered any one of those four criteria, it would be a capital lease, and if not, it would be an off an operating lease. The challenge with the operating leases is that all of the liability associated with all those payments is off of the balance sheet. And so early 2000s, a lot of scrutiny, a lot of fraud cases and exposure to these challenges where you had companies with loads of commitments and liabilities, but not on the balance sheet. So the SEC drove the charge. The GASB and the IASB led a joint effort as they tried to converge on standards to create one globally. And the GASB followed suit shortly thereafter. And so we've got in 2014 is when GASB finally issued their preliminary views and exposure draft came out in 2016. 2017 is when this was listed and it was on track for effect being effective January this year. One of the, I guess the key difference, and we'll talk about this a little bit, is that the underlying challenge related to the previous standard in that we have these obligations that are off balance sheet are now corrected. Now there's on the balance sheet a liability associated with the leases and the payments associated with them. And there is a lease asset on the books, which is essentially an intangible right of use for those lease assets.

And I think, you know, when everybody started down this path, the idea was to converge all of these standards into one kind of unified standard. We don't have one standard. We still have, you know, three very different flavors of this. And, and it's interesting because there in some ways the standards are similar and then they are all very unique in different ways. And so, but where they are similar is they're all, all very complex in how these calculations are run and how the accounting is managed. This is long overdue. The SEC estimated when they started investigating this that there was $1.25 trillion that will come onto the balance sheet as.

A result of this.

There's going to be greater transparency, better disclosures, things like that. But at the end of the day, it really represents the economic substance of the transactions. And so with COVID that's happened. What we've seen in our customer base and obviously that we're hearing in the marketplaces, there are renegotiations of these, of lease agreements that are happening wholesale, globally. And so with these renegotiations, the challenge is modifications under any one of the three new standards, GASB included, is they're very complex and difficult to manage. So the GASB has taken action. They had a meeting about 10 days ago to go over this and they're going to release something here in the next week. But Nathan, you want to.

Yeah, yeah. So the exposure draft is out and they're doing a very condensed timeline. So it's similar to the US FASB, the International Accounting Standards Board and the GASB, they're all very unanimous in their view that a one year extension, given our global pandemic COVID 19 challenges we're having. And so it's only a two week comment period and then they'll be making a final statement, reviewing any feedback and making a decision on May 8, just a couple weeks from now.

All right, so now with that behind us, we want to get kind of into the nuts and bolts of what the accounting entails. So under the previous standard GASB 13, there were two different types of leases. There were capital leases and, and operating leases. Capital leases are in substance identical. They've just been renamed to finance leases. So it's kind of a new terminology. And what used to be classified as operating leases are now going to be classified as finance leases. So there's no longer a determination between two different classifications or types of leases. It's all going to be wrapped up under financing leases, which in one way simplifies the standard quite a bit. The fasb, on the other hand, they elected to maintain two different types of leases. And so auditors come in and now there's, there's a challenge to, to prove out to the auditors exactly why you classified one as operating versus financing. So, so in that regard this has been simplified. However, now all those operating leases are going to be moved to the balance sheet. So you're going to have to calculate the net present value of all the future payments for those leases to come up with your lease liability. And of course, GASB elected to net out any lease incentives that come along with that of that, you know, net present value number. And then the asset is your lease liability plus any prepayments and plus any initial direct costs associated with entering into that lease. So what this means is your leases will go, you know, we've got a snowplow lease over here, $500 a month for three years. Under the old standard you simply hit vehicle expense or rental expense and then have accounts payable on the other side. This is now changing. So now you have to calculate the net present value of those payments to come up with the liability and the leased asset. And then you've got the amortization of that leased asset that's straight lined over the period. And you also have the lease liability that's burned down using the effective interest method. So that is what's represented in these, you know, month one and month two, five line journal entries. And of course, because it's effective interest, you're going to have a different journal entry every single month for the life of the lease. So certainly it's possible to calculate this in Excel. Certainly it's easy, you know, to do this on, you know, one or two or a handful of leases. When you get into real volume, it can become, you can see how this would become a major challenge. So we want to talk about transitioning going from GASB 13 to 87 here.

Yeah, I know a lot of folks were planning and already had teams in place to properly address this, given that it was initially slated to be effective as a 1:1, 2020 this year. That being said, even in light of the extension for year, I think, you know, beyond business continuity, to the extent the accounting teams have the time and availability, the unanimous consensus or unanimous kind of opinion is that the adoption of this standard took a lot more effort than people originally anticipated. And so get your teams in place and there's a contractual review to see whether there are contracts that meet the definition of a lease where there's an identified asset and there's consideration that's paid for that for the use of that asset and then the systems piece is just a small part of that. So we obviously are coming here from a system provider, but recognizing that getting data in the system that will help immensely in getting debits and credits right, getting your disclosures, all of that, but ultimately the inputs into that system is what's really critical. So the lease testing, validation, deploying it and impacting your or updating your systems and your processes to reflect the new standard.

Yeah, and one thing that I did want to highlight through this whole approach is that you may not think that you are impacted by the lease standard, and there are companies that aren't. You know, if you have an office lease or vehicle leases, then you certainly are to address that question, whether or not you're impacted, the auditors will come in assuming that you are impacted. So even if you don't believe that you are, we still recommend that you do an internal review, or at least you document some sort of internal review that you've looked at contracts and you've assessed all your obligations to see if there are any that qualify as a lease. And that way you can be prepared for when the auditors ask the question question if you don't actually have any leases, and then it'll at least give you some documentation to support, to support that journey audit.

One of the big underlying challenges is that, you know, the debits and credits are challenging. And as Adam showed in the journal entries, it's a little more complex. One of the most often overlooked items within the new lease accounting standards as the 87 are the disclosure requirements. And so the big challenge related to that is where the data, where is the data? Where does it reside, typically in the contracts and how you get it into the system. And then perhaps a third question there.

Would be, how do I aggregate across.

And so whether you have capturing data in multiple Excel spreadsheets, we've seen so many spreadsheets at this point that, you know, and they, they all vary, but they are universally challenging. And so that's ultimately the big challenge that associated with GASB 87 is that there's a lot of data to get.

And aggregate across the board.

Excellent.

So GasB87 is complex. These are some of the new requirements under the standard. It's important to note that it's not just the accounting, but it's also the disclosures that are impacted. And then of course, any modifications, renewals or things, changes to the leases that you were not anticipating at the outset do have to be recognized as either modification or termination, things like that. We're not going to go through each one of these, though.

The fundamental challenge here is, you know, one of the thought leaders, I think, in accounting, Steve Bragg, he says, my concern is smaller companies. There's no way I can see them getting this right. That's certainly been proven in our experience with the companies we've worked for, is that, you know, big companies, they can throw a big team of CPAs, accountants, get outside consulting work to help out for smaller teams. This is going to be a lot of effort and PwC highlighted how system and process changes. So it's not just getting a system to work for you, but they're typically going to be process changes that relate to those underlying systems.

Excellent. So now we want to get into automating the new standard. So as we kind of navigate, you know, we're very much engaged in the lease accounting software world and as we've looked at the different products on the market, they really fall into one of three categories. The first is a real estate heavy solution. So if you have hundreds of real estate leases and you want to get a grasp on maintenance, on being more efficient at managing your space, those are the solutions that are really effective at that. They've also bolted on a lease accounting side. And so if they can to some degree meet that requirement, however, they are weaker on the accounting and the flexibility. These are rigid systems that have been in place for decades. Oftentimes they're on premise solutions and so they can be a challenge and expensive to stand up. But again, if real estate management is your aim, that's probably the best bucket for you. Two are these lease point solutions. These are newer solutions that have come out in recent years to address the new standard. These solutions are good on the accounting front. They're typically not as good on the real estate management side, but they are good on getting the accounting right. However, you do lack that integration with your ERP solution. So foreign currency becomes a major issue you've got on the implementation. You have to bring in all of your segmentation, your accounts, your vendor information and subsidiary hierarchy information to get those properly set up so that they can export the data for you correctly. These really stop. They'll present some reports for you and some data for you, but they stop there. Inputting that information into your GL is really your responsibility. And then you've got ERP embedded leasing tools. These are accounting heavy, very accounting focused, but they take it all the way through the lease transactions, all the way through to the GL accounting for any intercompany variability, any foreign currency, things like that that may be complex, these will typically address those requirements. The nice thing about these is they are often far less expensive than the other two because they're built into the core of your current gl. And then the second is the ease of use and getting the accounting right. Right. Tying into your foreign currency rates and things like that make them a lot more effective that way. This is the bucket that we fall into from the netsuite perspective. And there is, you know, not the discount, there is a lot of property and contract management capabilities that are on this side of the house as well. But again, these are accounting first. If accounting is the problem, transitioning to new standards the problem, that's certainly one of the most efficient ways to do it. So. We're going to go into a quick overview of NetSuite and our solution to kind of walk through what automating it looks like. But again, we've got the lease accounting life cycle. It's really not just a transition, it's managing the process for the long term. And so as you look at, you know, processing monthly, monthly transactions, these modifications, all the disclosures that are changing and coming out that you have to release on a regular basis, all of that needs to be taken into account as you move on to this new, under the new standard. So with that we've got a demonstration that we are going to walk through. So I am logged into netsuite and I'll make my screen a little bit larger here. We are a native solution. So all of the, all of the processing power and code is built directly into the netsuite instance here that we're looking at. And this is the dashboard. It's fully customizable, configurable. This is set up for an accountant. But what I wanted to do is I want to go in and actually set up a lease under the new standard and walk through some of the inputs that are required and some of the capabilities that at least our system has for capturing that information. So I'll set up a GASB 87 lease here. Spelled that right.

And while Adam's kind of filling that out, you know, one thing to highlight now obviously for those that are already on NetSuite, this is, this is essentially a no brainer. But even for those that aren't, this can act as a standalone solution similar to that center, center column, center bucket that you had referenced to. You know, you can get a minor license to NetSuite and then have this, and have this operate as your standalone solution as well.

Perfect. So I've got a real estate lease that I'm setting up here. This schedule information right here and below is really where we get into some of the core accounting pieces of it. So I have set this up with the possession date being January 1, 2020. It's a 24 month real estate lease and the initial payment's 15,000 with an incremental borrowing rate of 5%. Now if I had any prepaid prepayments against this or any initial direct cost, it would impact the right of use asset. But A lot of real estate leases, sometimes they'll come with free rent periods, or sometimes they'll escalate. Oftentimes they'll escalate in price. So I'm going to say on January 1, 2021, in the second year, this is going to go up to $16,000. So I'll add that and then I'm going to save this. And I've captured, there's a lot of information that we can capture about the real estate, about the contract provisions, things like that. But, but I've captured the required information to be able to generate the, the schedule, the amortization schedule and get the accounting right. So as I look here though, there's a couple of things that I wanted to highlight first while it's processing the schedule and refresh it. It should be done now. We will capture here. If I click on this, you can see the help and the definition around exactly what constitutes that initial payment amount and what we do from there. So really, essentially what we're doing is trying to make this transition as easy as possible as you input this key accounting information. But what the system has done is it has calculated the lease liability amount, taking that 15,000 in the first year, 16,000 in the second year, and coming up with a net present value at a 5% discount rate. And then of course, it's calculating that leased asset by, you know, modifying it for any prepayments or initials or costs. We don't have any. So the lease asset is exactly the same as the lease liability in this example. From here, I want to take a close look at this because this is, I've got my effective interest rate that's built up the amount that's going to burn down that lease liability over the lease term. And just make sure. I want to make sure everything's okay. But once I'm good with this, one of the key control points that we see is commencing this lease. And we want to make sure we restrict the access to do that to the individual that is responsible for reviewing this before it goes into play. One thing I did want to highlight is we have the ability to export this table into Excel so that you can rerun those calculations. There's no voodoo in here. You just use the basic net present value, you know, functions inside of Excel to do that, to come up with this. You can rebuild the schedule very easily, send it off to your auditors so they can validate it. But now that I've commenced the lease, I do want to walk through. This is typically where the other solutions will end. Those lease point solutions will end. They'll give you this information, but then it's up to you to take this into the gl. This is where I wanted to walk through the processing of an actual journal entry here. So I'm going to go in and run this for the lease that we're looking at now. Typically if I'm the, you know, if I'm the controller or whoever's responsible for running these journal entries, I'm going to do it for my entire lease portfolio. But in this case I'm just going to run it for the one that we just set up just to not mess up any of my demo data here. But while I do this though, we've got this record that highlights who did this is really not a trail. Who did it, what parameters were set when this was run. And then once it's done processing, the batch summary will highlight exactly what's come out of this. So you can see the journal entry to set up the lease asset and the lease liability. And then January, February and March is journal entries for this lease. I can drill into those from here, but I'm going to go back to my lease record and take a look at them directly here on the record so you can see the initial balance. And then I'll click on one of these amortization entries to show you what the system has generated here. Initial balance we're taking, we're setting up the lease asset for 354,000 and that lease liability as the offset to set this lease up. And that comes right off the schedule. As you, as you would guess the schedule. We don't do any processing or calculations when we create the journal entries. Everything is calculated in advance on that schedule, which is why we view that as one of those key control points for setting this up. This is the amortization entry. So this is that five line journal entry that'll be processed every single month. You can see we've got that the expense which is really just the straight line of the lease asset liability that's taking into account the payment minus the effective interest to get back to the, the liability burn down component of this. So with that I wanted to talk about. So really effectively what I've done is transition. We can take all of your lease data, upload it in a CSV document, get it into the system, run these schedules and start them all at once. We've got, I've started a lease here, but we can also, you know, cut over midlife and we've helped many, many companies Transition onto the new standard at large volumes. In some cases of leases, especially with.

A GASB where you have full retrospective, it's really important to get down to the beginning lease term and possession date in order to get those built out entirely. And then we can start booking journals from our GL transition forward. But if we're doing topside, just depending on whether things are getting booked in the GL or whether going to be top side in part of your retrospectives, restatements, that's all that information is right there and available for you to pull.

And one thing I wanted to highlight now certainly so we've hit the accounting piece, but you know, any payments that we make for this lease, I don't have any because this is a brand new lease. But any payments that we've made will show up here. Any maintenance costs, other expenses, CAM charges will show up under this other related transactions tab. We've got all the accounting information to designate, department, class, location, who this is assigned to. You know, any of these other key components for disclosures, contract provisions is a big one. If you have any renewal options, expansion termination options or things like that, we can set those up here and track in very, at a very granular level those provisions. And then we can also set triggers to send out reminders to the relevant parties about these upcoming changes or potential changes to the lease. Property information is where we can track square footage, you know, the total space that you're leasing and any additional information. We can add fields here and build this out as desired. We can upload the actual executed lease agreements here. And then of course any modifications or terminations to the lease will show up under these two tabs. And then our system notes is the full audit trail behind what's been happening around this lease record. So if Nathan for example, came in and changed this, I could easily see that he was the one messing with my lease here. But I'm going to go in, I want to modify this lease and highlight how easy this is. This is one that a lot of our customers are up and live and everything was going great until they, you know, management started renegotiating a lot of these lease agreements. And so I'm going to make a tweak here to a lease agreement to show how easy this is to change. We can, we can write down the lease asset, we can do a decrease in scope, which is accounting for, you know, if you had two floors of a building, you cut it down to just one floor, you renegotiated that it would be a decrease in scope. Both of those would have a P and L impact or P and L impact. And then the standard modification is purely balance sheet impact. And so what I'm going to do here is just say that, you know, we've got a concession in April of this year that we don't have to pay any rent. And I'm going to have that concession go on for April, May and June. So in July, our rent is going to go back up to $15,000 where it was before. But then we're going to extend this contract through March of 2022. So we're simply going to add three months to the life of this contract. And so I'm going to change it. So 11 22, I'm going to add those $15,000 payments back in. So it's going to go the first year was 15,000 supposed to be, but we've got these rent concessions. Second year will still be 16. Then we have to make up for those three missed payments next year. So I've made some minor tweaks to the lease here to account for the COVID renegotiation. When I go in and modify the lease, what it's going to do is it's going to now look at the future payments and it's going to recalculate the net present value for all future payments post the modification. So, you know, you can see as we were on here for January through March, we've already booked journal entries. That's going to be locked down. That's not going to change. What we're going to do though, is recalculate that lease liability balance, adjust the asset in the liability accordingly, and then rebuild the schedule so that go forward, we're going to have a different amortization amount. We're going to have a different, different payment structure, and we'll account for that change. So it should be done here. It's processing the journal entry at the same time it's rebuilding that, that schedule. So you can see here, our lease liability went from $313,000 down to 309. And we had the same change value change between the asset levels. So if I open the modification journal entry, this is going to show a decrease to the asset of 3,700 and a decrease to the liability of 3,700. There's no P and L impact for a standard modification. But then you can also see that amortization amount has changed over the life of this lease. And now the lease, instead of ending in December of 2021, it's now going through March of 2022 to account for those additional months that got tacked on as part of that negotiation. So we make it very easy to do this, these modifications, and we've got a lot of customers that are coming and pay as close attention during the training. And so we're walking through how to do those modifications again and helping them navigate some of those renegotiations that are ongoing. One thing that's important though is if you did make a mistake or you needed to change another variable in that modification, we can easily undo the modification, restore this to what it was before you made any change, make the proper tweaks, and then, and then remodify the lease. I've walked through at a very high level. Obviously there's a lot of functionality that we didn't have time to hit on today. But I want to close out with some of my favorite reports here. The first being the least balanced roll forward report. And then we've got waterfall report and the payment waterfall report. So this one is really what you're probably used to on the fixed asset roll forward report, really the standard for providing detail on your asset changes to the auditors. This is what provides the detail around the, the lease changes to your auditors. So if we dig in, we had our real estate lease here that we've just created, you can see that we had another change to our balance for $3,700. And that represents that modification, that journal entry that we looked at earlier. And I can drill in from here to the lease record itself, or I can drill into the journal entry just with a simple click here. So what we recommend is that you take this report, you expand it out, export it into Excel, send it over to the auditor, can make their selections, and then it's very easy with a click, you can drill right back into the detail here, which is what I just clicked on from that report. So I really like this report. I think this is going to be the standard going forward for the auditors to look for as they do their audits. The next one is an expense waterfall report. This provides some color around your future expense and we can split it by amortization or interest only and take a look at those different costs. This will help as you, as you prepare the disclosure components of the transition. And then the last piece is the payment waterfall. This gets into cash flow. We're looking at the actual outflow of cash that relates to these, not just the expense portion of it. And so this is, you know, we can filter and forecast on this route as well. So with that, again, we could go for a few more hours on some of the details around what we offer. But I really wanted to show how quick and easy it is to set these up. And again, we can move very fast on getting customers transitioned on in the new standards. So with that I am going to move back over into our presentation here.

So again, you know, thank you so much for taking the time today. We're really excited about lease accounting and certainly are here to help you as you look forward for this upcoming year and getting ready for the new January 2022 commence date or effective date of the new GASB 87 waste accounting standard.

Yeah. And thank you for your time. And you know, one thing I didn't offer during the session is we do have templates if you, if you plan on using Excel, we certainly have templates that you can leverage. If you just want to reach out, we'll make those available to you individually that may help, may help with that transaction transition. But we are here, we're here to help and we're. Yeah, yeah. Great for your time today. Thank you.

Thank you.