Understanding ASC 842 Lease Accounting

All right.

Hello. We'll go ahead and get started. Welcome again to the Net Gain webinar.

Series that we have here.

We're starting with 842. We've got a few IFRS to accommodate the different time zones around the around the world. And then we also have a GASB webinar if you are interested up in the upcoming next couple of days here. But yeah, this one is focused on all things842 which is the most exciting a part of the lease accounting world to be in right now. So we'll move in. We've got some updates that came out today from the FASB that we'll touch on. So anyway, we're excited to be on with you. Thanks for joining. So I'm Adam Riches and a little bit about my background here. I'll be one of the presenters and I'll be actually doing the demo, the live demo today. And I've been here at NetSuite since its inception for a little over two years. Sorry, net gain for a little over two years. And I was at NetSuite right before that for about four years. And then I had various controller roles for a couple of different publicly traded companies before that in industry. And then I started out my career as an auditor at Ernst and Young, which is where incidentally I met Nathan Smart here. So I'll kick over him.

Thanks Adam. Yeah, this is Nathan Smart. As Adam mentioned, we we shared a client together working 60, 70 hours in the beautiful June, July weather of Colorado. And so we've been close ever since. I wanted to give way back my background. I spent five years at Nurse and Young as an auditor, a couple years closing the books for a large hospital group here in the Denver area and then spent close to a decade with Deloitte Consulting doing a lot of large scale finance transformation projects, working with a lot of systems and implementation. So kind of the intersection between the process accounting and systems. So we're thrilled to be with you and talk about one of our favorite topics.

Yeah. And feel free throughout the session to hit there's a Q and A button. Feel free to ask any questions as we go throughout and if we don't get to your questions during the session, we could certainly we have some time earmarked at the tail end to make sure that we do get all of your questions addressed. So yeah, feel free to ask as we go through this. So what we're going to touch on today is really the evolution of accounting and how we got to where we're at with the new lease Accounting standard we're going to talk about, actually. Well, in between there, we've got some news from the FASB that has just come out this morning. They've got their draft release on potential extension to the timeline, so we'll touch on that. And then we'll also talk about the impacts of COVID and what that has had on a lot of our client base and how they're managing some of the lease negotiations that are taking place right now. And then we'll talk about, you know, 842, the transition, and then I will go through a live demo to show how you can automate lease accounting under 842 as well. And then we'll have, like I mentioned, some time at the tail end for Q and A.

Excellent. So without dipping into going 400 years ago, let's go just 40 years ago, we wanted to give a quick evolution around lease accounting just to give a context of where we are today. And I know 842 has been out there for a while, but I wanted to give kind of the context for why it came about, why it was important, what the various activities involved that led up to that were. And so the accounting, as was known up until recently, really dated back to the mid-70s, where the FASB issued FAS 13, which was essentially your two classification of leases, which really had these four criteria that were indicators of whether a lease in substance was a financing arrangement or whether it was essentially a rental. And so what those, those criteria were really in place for those, those 40 years. And the IASB internationally just six years after the fact. And the. There was a big challenge here because a lot of lease agreements were structured around making sure they met the desired outcome. So I remember back in college, early 2000s, we ran case studies of, you know, leasing companies, you know, the airline leasing company and then the airline lessor and lessee, none of them had on their balance sheet. So it was a big question, where did these assets exist on nobody's balance sheet? And so it was interesting case study. So really during that the early 2000s, we had some financial, some, some frauds, some challenges around off balance sheet financing. And so the FASB and the International Accounting Standards Board, as part of their overall effort to converge standards globally between the FASB and the IASB, decided to undergo a joint project in 2006 on leases. It took them three years to come up with their preliminary views. I remember reading, you know, a lot of the, back in the early 2000s about the kind of the arguments back and forth. Clearly the consensus early on was that a lease agreement represents a liability and there is an asset in that I have future benefit on my right to use an underlying asset. So the FASB and the IASB absolutely agreed on that. The challenge is they had kind of their great schism where they separated in terms of some key fundamentals and it really related around the balance between ease of implementation and accuracy on the, on the P and L and where things. So unfortunately they came to two different opinions. International Accounting Standards is a single classification type, whereas the FASB elected to maintain the two classification types, operating and financing. From a balance sheet perspective, they wanted things to come on the balance sheet, but they did thought that the P and L should not be impacted. There's a good slide that kind of highlights what that looks like. So fast forward a few more years. We're getting just to a few years ago, ASC842 became public in January 19th. So for fiscal years beginning after December 15th, 2018, and the overall consensus, and we'll talk a bit today about this, the consensus, it definitely was a bigger undertaking than folks had realized. And so a lot of the public accounting or public companies who were, who were slated to adopt in January 2019, there was a lot of effort in order to get the disclosures right, to get all the calculations. And so in October 2019 there was a realization that a one year jump from public companies to private companies would be challenging. So that they just seven, eight months ago delayed AC842 for private and not for profit companies. And this was part of the broader FASB effort to essentially create two tiers and for major accounting standards have a two year delay between the adoption, between the two buckets. And so that came out October 2019, just handful months ago. And then here we are pushing towards January 21st as an effective date. But as we'll show, the FASB actually met a handful of weeks ago and this morning issued their exposure draft on another delay for another year. In light of our current challenges we're all having with our global pandemic. Covid19 so but the big takeaway of this evolution is that what used to have this entire bucket of leases where they were firm commitments to companies, they were off balance sheet. So now we're in a situation where most leases are back on or not back, but they are now on the balance sheet.

Yeah, thanks. So what I mean, the reason this happened is greater transparency. This drove accountants, at least accounting purists crazy that these liabilities were not sitting on the balance sheet somehow and somehow accounted for but like all things obviously the pendulum has swung from the extreme of not having much at all. Well, nothing on the balance sheet and then just some minor disclosures to now, you know, significant impact in layers of complexity.

So.

Anyway, yeah, it's going to create a lot, much greater transparency and the accounting purists will be much happier after this isn't sure.

Yeah. And so I just wanted to highlight with you, I mentioned that just a handful of weeks ago the FASB met virtually over zoom. We were dialed in from our remote locations as well and they had discussed this and it was very clear the direction unanimously of the board that it wanted to proceed with staff recommendation that in light of our challenges we're having right now with COVID 19 and business continuity challenges alone, in addition to staff workload, there was clearly a strong push and desire to provide push it out a year. And so the FASB is seeking public comment right now. So they've issued their exposure draft. The only real change in the exposure draft is the date. So from an accounting perspective there is. The accounting is essentially intact. It's just for private companies, those that weren't required to adopt in 2019, we'll have another 18 months of Runway. I think the key learning from the delay eight months ago was that a lot of people weren't putting the time and effort into it that they needed. And then in light of COVID I think it's another additional challenge. Yeah.

So to be clear now it's a full three years after the public companies and certain private companies adopted. There's going to be some concern on the feedback or the comments back certain. There's going to be some concern around comparability now because now you have public companies running financials under a completely different standard than private. And so there's going to be some concern there. So one thing that we would encourage you to do is to submit comments to the FASB and and have an impact on this. But overall, I mean, I think this is a great way to relieve some of the pressure that the private companies are feeling in other areas of the business, instead of trying to tackle this, they can focus on the core business. And I think the FASB was pretty united in their efforts to try to give some relief to private companies that way. So we think it'll likely stick.

And then following up from here, there is one clarification. I apologize for the text here, definitely not going to read it, but there was a question that FASB had relative to the lease concession. So we've talked with a lot of our customers. And we just know globally there's plenty of challenges companies are having currently in meeting their lease obligations. So there's a lot of conversations between lessors and lessees around their lease agreements and what kind of concessions and such. And so the fasb, that was one of the questions that came up to the FASB staff on some clarification on the scope of these. So a lot of these concessions are really global in nature in terms of entire population of leases. And so there was some clarification saying, hey, do I really need to treat every single underlying lease as a lease modification? So the FASB highlighted the obvious comment that the guidance did not contemplate some of the challenges we're obviously facing currently. And so the underlying premise in requiring a modified lease to be accounted for as if it were a new lease would not apply. And so this is a nice relief for companies that have modifications in scale too. And so what they highlight is that you can treat them consistent with how those would have been accounted as though they were in place early on in the lease. And so very next we have the actual two options that the. And so most common scenarios we're seeing is that a lot of lessors, landlords, etc. Are offering deferral payments, so taking perhaps extending the lease an additional few months or pushing payments to the. But in substance, the overall lease agreement is effectively intact in terms of the rights and obligations as well as the consideration that's provided. And so you have the two options. I'll jump first option B is you can treat it like the current accounting standards allow you to. So what that means is if I take an example where I have a three month deferral, I would have the modification where I take those three months, I extend my lease agreement, I recalculate what my present value of future payments is that my incremental borrowing rate and I would remeasure the liability with the offsets, the right of use asset. That's everyone is perfectly welcome to use existing guidance for that, but they did want to give a sort of practical expedient under scenario B.

It would, it would be kind of a standard modification where you're just adjusting the payment run and so. And I'll walk through that when I go through the demo. So that's pretty straightforward. Now back to A. Yeah, now A.

Is essentially a nice, it's sort of a practical experience where what a company can do now is they can take their lease liability, their amortization schedules that they've built out for the entire lease contract and they can not change the liability not change the asset but rather make any changes in payments as a reduction to their receivable payable associated with the lease so that is a nice kind of roundabout way to not worry about adjusting your entire schedules prospectively but just on the offside recognizing that those payments will in time balance out towards the end of the lease yeah which.

Isn'T super exciting at least from my perspective like I think that one is meant to be kind of a relief but it's just another it's another thing you got to look at on your balance sheet another balance sheet account to reconcile right yeah so the question is who's impacted by the new standard Right and at the end of the day it's anybody who is giving consideration in exchange for the control to use an identified asset so they are very particular about identified assets which put software into this kind of no man's land of software lease or well this is where.

The definitions differ between.