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Most calendar year-end public business entities (PBEs) adopted the new leases standard on January 1, 2019. Here are some key reminders about the lease disclosure requirements, recently issued guidance for lessors, and implementation considerations to help companies prepare for their first quarter reporting under the new leases standard. We also discuss certain implementation considerations, including the accounting for sale-leaseback transactions, the impairment of a right-of-use asset (ROU asset), and build-to-suit leases.
The disclosures under the new leases standard are more extensive than under the prior guidance. Further, calendar year-end PBE’s will need to include all annual and interim lease disclosures starting with their March 31, 2019 quarterly filings. This is due to the SEC rules that require companies to provide both the annual and interim period disclosures for each interim reporting period in the initial year of adoption of a new accounting standard.
Companies do not need to provide the interim or annual disclosures required by the changes in accounting principles standard during the year of transition to the new leases standard. The transition guidance in the new leases standard explicitly removes the requirement to provide the annual disclosures required by the standard on changes in accounting principles. However, it did not address interim reporting. In March 2019, the FASB issued new guidance (ASU 2019-01) which clarified that the interim disclosures related to changes in accounting principles are not required during transition. This is consistent with the transition guidance provided in the new revenue standard.
During transition, companies have questioned whether a lessee’s disclosure of five-year minimum lease expense (and a lessor’s disclosure of five-year minimum lease income) from the most recent Form 10-K needs to be carried forward into interim and annual filings. The standard requires that a company electing to adopt the leases guidance as of the effective date (i.e., January 1, 2019 for calendar year-end PBEs) provide the disclosures required under the old leases standard for all previous periods that follow that standard. For calendar year-end PBEs, this means they will need to include the five-year minimum lease disclosures from their 2018 Form 10-K in each of their 2019 quarterly and annual filings. This is in addition to the five-year minimum lease disclosures required under the new leases standard as of and for each of their quarterly and annual filings of 2019.
Companies have also raised questions related to whether it is appropriate to combine the ROU assets and lease liabilities when they have both operating and finance leases within the same class of asset. The new leases standard prohibits lessees from including operating and finance lease ROU assets and lease liabilities in the same financial statement captions. The ROU assets and the lease liabilities may be included in any financial statement captions that does not result in a misleading presentation, as long as the two classes of assets or liabilities are in different financial statement captions. Lessees may want to consider the significance of leases associated with each classification (operating or finance leases) in determining where to classify the associated ROU assets and lease liabilities.
For more information on the presentation and disclosure of lease arrangements under the new leases standard, refer to Chapter 9 of our Leases guide.
In December 2018, the FASB issued guidance to simplify lessor accounting (ASU 2018-20). The new guidance requires lessors to exclude from variable payments all lessor costs, such as property taxes and insurance, that the lessor contractually requires the lessee to pay directly to a third party on its behalf. This guidance is applicable even if the lessor knows or can readily determine these amounts. As a result, these amounts are excluded from the lessor’s income statement. Conversely, reimbursements from lessees for costs that are paid by a lessor to third parties should be accounted for as revenue by the lessor and shown gross on the income statement. This guidance only applies to payments by the lessee of variable lessor (or sublessor) costs, and not to the payment by the lessee of fixed or variable rental payments.
The new guidance also allows lessors to make an accounting policy election to exclude sales tax (and similar taxes) collected from lessees from contract consideration. Finally, the new guidance clarifies that variable payments allocated to nonlease components should be recognized in accordance with other guidance (e.g., the new revenue standard).
For more details on this guidance, refer to our In brief US2018-25, More changes to ease lessor adoption of the new leases standard.
As transition to the new leases standard nears completion, companies are shifting their focus to on-going lease accounting issues. One issue is sale-leaseback accounting and the interaction of the new leases standard with the accounting for sales transactions.
Sale-leaseback transactions involve the sale of a property and a concurrent lease of all or part of the property back to the seller. Sale-leaseback arrangements are economically attractive for seller-lessees in a number of situations, such as generating cash flows or providing temporary transition space to a seller-lessee that is relocating to a new property.
Under the old lease accounting standard, prescriptive limitations on any form of “continuing involvement” made it challenging to achieve sale accounting, particularly for real estate sale-leaseback transactions. Often the seller-lessee retained the property on its books and treated the transaction as a financing (i.e., a failed sale-leaseback).
With the adoption of the new leases standard, the guidance has shifted from whether the seller-lessee has continuing involvement in the property to a focus on whether a sale has occurred. For a sale to have occurred, the seller-lessee needs to determine whether control of the asset has been transferred to the buyer-lessor following the guidance in the new revenue standard. This requires companies to consider the principles of control (i.e., the ability to direct the use of, and obtain substantially all of the remaining benefits from, an asset and prevent other entities from doing so). The following are indicators of the transfer of control in the new revenue standard:
Not all of the indicators need to be present to conclude that control has transferred to the buyer-lessor in a sale-leaseback transaction. Rather, the factors should be evaluated collectively to determine whether the buyer-lessor has obtained control. As the seller-lessee performs this assessment, it should consider the transaction from the buyer-lessor’s perspective.
When assessing whether control has transferred to the buyer-lessor, companies must also consider whether there are any repurchase features in the contract. For example, a seller-lessee may have the right to repurchase the asset (i.e., a call option) or the buyer-lessor may have the right to require the seller-lessee to repurchase the asset (i.e., a put option). Repurchase features must be evaluated under both the new revenue and new leases standards to assess whether control has been transferred to the buyer-lessor. The standards generally preclude sale recognition when the seller-lessee has a substantive repurchase option or obligation with respect to the underlying asset, because the buyer-lessor would not have obtained control. This is an area that can require considerable judgment, particularly if the contract provides the seller-lessee with a “right-of-first offer” or “right-of-first refusal”.
The evaluation of a sale-leaseback transaction is also impacted by the classification of the lease. If the lease is classified by the seller-lessee as a finance lease or if the lease is classified by the buyer-lessor as a sales-type lease, then a sale has not occurred (as the seller-lessee has retained control) and the transaction would be accounted for as a failed sale-leaseback.
For more information on accounting for sale-leaseback transactions, refer to Chapter 6 of our Leases guide.
Another consideration relates to the interaction of the new leases standard with the long-lived asset impairment guidance. Under the new leases standard, the lessee will initially record an ROU asset and a corresponding lease liability. The ROU asset represents the lessee’s right to use an asset legally owned by another party for a period of time. The ROU asset receives accounting recognition as an asset because a lessee has control over an economic resource and is benefiting from its use. The lease liability represents the obligation to make payments for that right of use.
The new leases standard states that an ROU asset is subject to the long-lived assets impairment guidance. Long-lived assets are grouped at the lowest level for which identifiable cash flows are largely independent of cash flows from other groups of assets and liabilities when testing for impairment. One way to determine if the asset group should include an ROU asset is to consider if the asset group would have included the lessee’s rent expense in its undiscounted cash flows in an impairment analysis prior to adoption of the new leases standard.
The first step in the long-lived asset impairment guidance is to determine whether the carrying amount of the asset group is recoverable. Recoverability is determined by comparing the carrying amount of the asset group to the estimated future undiscounted cash flows expected to result from the company’s use and eventual disposition of the asset group over the remaining life of the primary asset. If the carrying value of the asset group is greater than the undiscounted cash flows, the asset group fails the recoverability test and an impairment loss would be recognized based on the amount by which the carrying value of the asset group exceeds its fair value.
The new leases standard does not specifically address how operating lease liabilities and future lease payments should be considered when performing the recoverability test or when calculating an impairment loss. Therefore, companies should make an accounting policy to either: (1) include the carrying amount of the operating lease liability in the asset group and include the operating lease payments in the undiscounted cash flows or (2) exclude the carrying amount of the operating lease liability from the asset group and exclude the operating lease payments from the undiscounted cash flows. Under either accounting policy, there should not be a significant difference in the results obtained in the recoverability test. Further, if a lessee decides to include the operating lease liability in the carrying amount of the asset group, the lessee will also need to make an accounting policy election to either include or exclude the interest portion of the operating lease payments as a cash outflow in the recoverability test.
Once an ROU asset is impaired, lease expense is no longer recognized on a straight-line basis as the amortization of the ROU asset is “de-linked” from the lease liability. Prior to impairment, the amortization of the ROU asset is determined as the difference between the straight-line lease expense and the effective interest calculated on the lease liability. However, once the ROU asset is impaired, the lessee will continue to amortize the lease liability using the same effective interest method as before the impairment charge, whereas the ROU asset will be amortized on a straight-line basis. This causes the lease expense to be variable after impairment of the ROU asset.
While performing the impairment analysis related to the ROU asset, certain complexities may arise when identifying the appropriate asset group that includes the ROU asset. For instance, when a company ceases use of a leased building, it should consider whether the determination of its asset groups has changed.
Consider a company that leases a retail building with ten floors. At lease commencement, the company accounts for the entire building as one ROU asset under an operating lease. The ROU asset is the only long-lived asset in the asset group. On January 31, the company ceases use of one of the ten floors and enters into a sublease arrangement for that floor, which commences on May 31. On January 31, the company re-evaluates its asset group and determines it should disaggregate the ROU asset into two separate asset groups (i.e., a single floor to sublet and nine floors it continues to use). This is because the single floor is independent from the company's retail operations and will be recovered with different cash flows than the nine floors of retail space.
Furthermore, the disaggregation into two asset groups may be an impairment trigger for the single floor ROU asset. If it is impaired, it would be written down to fair value, amortized on a straight-line basis, and “de-linked” from the accounting for the floor’s lease liability.
Another consideration during transition is the accounting for build-to-suit leases, including derecognition of build-to-suit related assets and liabilities. In a build-to-suit arrangement under the old leases standard, the lessee was often required to account for the construction project as if it was the owner of the project (i.e., the accounting owner). Frequently, a lessee in build-to-suit lease arrangements recorded an asset for all construction costs and a liability for the construction costs that were paid by the lessor. In many cases, the lessee was not able to derecognize the project’s assets and liabilities after construction was complete due to the prescriptive sale-leaseback rules.
Upon adoption of the new leases standard, if construction is completed by the effective date (i.e., January 1, 2019 for calendar year-end PBEs), then lessees will derecognize any assets and liabilities that continued to be recognized solely as a result of the previous build-to-suit accounting. The asset is derecognized regardless of whether the lessee would have been the accounting owner under the new standard. However, when construction is still in progress as of the effective date, the transaction must be reassessed under the control-based build-to-suit model in the new leases standard. If the lessee is determined not to be the accounting owner under the new leases standard, the lessee will derecognize any assets and liabilities that resulted from previous build-to-suit accounting.
In these situations it can be difficult to determine how to account for the derecognition of the asset that was created in the build-to-suit accounting. This is because the asset can include lessee paid amounts that would have been recognized as assets even if build-to-suit accounting had not been applied (e.g., leasehold improvements). At transition, the portion of the asset that was not created solely because of the build-to-suit accounting should not be derecognized. For example, assume construction is complete by the effective date. If the lessee would have accounted for its arrangement as an operating lease had build-to-suit accounting not been applied, it must carefully review the payments that it made during construction to determine what the accounting for these payments would have been under operating lease accounting. The lessee’s operating lease accounting will differ depending on whether the payment was made for lessee or for lessor assets:
After adjusting for these lessee-paid amounts noted above, the lessee would derecognize the remaining amount of the build-to-suit asset and liability through equity as a cumulative-effect adjustment. Additionally, a lease liability and ROU asset for the lease (adjusting for the “prepaid rent” as noted above) would be recorded in conjunction with the general transition guidance.
For more information regarding build-to-suit accounting transition, refer to Chapter 10 of our Leases guide.
The new leases standard introduces accounting and disclosures that may require management to obtain additional information not previously available under their systems and business processes. As a result, companies may need to develop new processes and controls to obtain, analyze, and track the appropriate level of information. Management will need to consider the financial reporting risks associated with each new process and ensure controls are designed and operating effectively to mitigate these risks. The controls should not only address the initial accounting, but also the ongoing reassessment and related disclosures.
In January 2019, the Treasury Department released the final tax regulations related to the “toll charge” on mandatory deemed repatriation of certain deferred foreign earnings. These final regulations retain the overall structure and basic approach as the proposed regulations released on August 1, 2018, but also contain some significant modifications. Because the final regulations represent a change in tax law, any impact that this new information has on a company’s toll tax liability should be reflected in the financial statements in the period that includes January 2019.
Prior to the end of 2018, the Treasury Department also released proposed regulations on a number of other topics, including global intangible low-taxed income (GILTI), interest deductibility limitations, and foreign tax credits. While these proposed regulations are not law until they are finalized, they provide insight with respect to Treasury’s interpretation of the law. Calendar year-end companies would have considered the proposed regulations as new information when assessing whether any related tax positions met the “more likely than not” recognition criteria at December 31, 2018. The final regulations will need to be accounted for when issued, which may be in the next several months. As such, companies should continue to monitor the issuance of the final regulations and be prepared to assess their impact once released.
For more information on the accounting impacts of tax reform, refer to our In depth US2018-01, Frequently asked questions: Accounting considerations of US tax reform.
The new goodwill impairment guidance reduces time and effort by removing the second step of what was previously a two-step impairment test. However, the guidance does not impact the timing or order of impairment testing. This guidance is effective for calendar year-end PBEs on January 1, 2020, with early adoption permitted.
Companies that adopt the guidance for their annual impairment test must also apply it to any interim testing. For example, assume a calendar year-end company expects to early adopt the new goodwill impairment test in the fourth quarter of 2019 for its annual test. In that case, the company must also apply the new guidance if there is a triggering event in any interim period in 2019. Conversely, if the company performs a trigger-based interim test and recognizes an impairment under the current guidance, it must also perform its annual test using the same guidance.
For more information refer to our In depth US2017-03, Measuring goodwill impairment to get easier, and watch our video, which discusses additional considerations when adopting the new goodwill impairment test.
In July 2017, the Financial Conduct Authority, the UK regulator responsible for the oversight of the London Inter-Bank Offered Rate (LIBOR), announced that it would no longer require banks to participate in the LIBOR submission process and would cease oversight over the rate after 2021. Various industry groups continue to discuss replacement benchmark rates, the process for amending existing LIBOR-based contracts, and the potential economic impacts of different alternatives. The replacement of LIBOR is expected to be a continuing challenge for the financial markets and will impact various stakeholders, including financial instrument issuers and investors, administrators, financial institutions, and derivative counterparties.
On December 6, 2018, Jay Clayton, SEC Chairman, emphasized the importance of market participants planning for the transition away from LIBOR as a reference rate for financial contracts. Transition is one of the key risks that the SEC is monitoring. Chairman Clayton noted that the Federal Reserve estimates that more than $35 trillion of notional transactions referencing US Dollar LIBOR in the cash and derivatives markets will not mature by the end of 2021. The Alternative Reference Rate Committee (ARRC) convened by the Federal Reserve, which includes major market participants and participation of the SEC staff and other regulators, has proposed the Secured Overnight Financing Rate (SOFR) to replace US Dollar LIBOR in the US. Some of the benefits of using SOFR include that it is based on direct observable transactions and a market with very deep liquidity.
During her presentation at the December 2018 AICPA Conference on Current SEC and PCAOB Developments (the AICPA Conference), Sue Cosper, FASB Technical Director and EITF Chair, noted that she believes the expected phase-out of LIBOR may have more impact than some companies expect, calling it a “sleeper issue.” She believes determining the corresponding standard setting reaction to a LIBOR phase out is likely the most important project on the FASB Board’s agenda.
Rahim Ismail, SEC Professional Accounting Fellow, also noted at the AICPA Conference that the SEC staff is aware of the potential accounting implications of the transition from LIBOR. He noted that the FASB has been making progress, adding the Overnight Index Swap rate based on SOFR as a benchmark interest rate (ASU 2018-16) and adding a project to its agenda to consider changes to US GAAP that may be needed because of the transition away from LIBOR. Ismail also discussed a consultation from a stakeholder regarding the impact of the anticipated transition away from LIBOR on existing cash flow hedges as it relates to hedge documentation, the probability of certain forecasted transactions, and the effectiveness analysis. For more details, see our In depth US2018-27, Highlights of the 2018 AICPA Conference on Current SEC and PCAOB Developments.
As 2021 approaches, companies should continue to plan for the LIBOR phase-out and monitor communications made by the ARRC, FASB, SEC and other regulators.
For more information, refer to PwC's dedicated LIBOR and reference rate reform page.
As the UK continues to negotiate its exit from the EU, companies should be considering how this new political landscape will impact their organizations. Irrespective of the outcome of the negotiations, whether that be with or without a deal, there will likely be significant changes for many UK companies. However, this is not just a concern for UK companies. Brexit may also impact companies doing business with the UK, as well as those with substantial UK operations. For some companies, the UK’s future relationship with the EU remains too uncertain to take action. However, by now companies should have identified and assessed the Brexit-related risks that apply to their company and should be considering the impact on their accounting and financial reporting. Some of the accounting and reporting areas impacted include: financial statement disclosures (e.g., risks and uncertainties), restructuring, tax accounting, impairment, and valuations.
For further details on these and other accounting considerations, listen to our podcast, Brexit: Five things you need to know about the accounting considerations. For considerations under IFRS, see In depth INT2018-15, Accounting implications of the UK’s Brexit decision.
On December 21, 2018, the SEC published a request for comment soliciting input on the nature, content, and timing of earnings releases and quarterly reports made by public companies. The Commission is seeking feedback on how it can reduce the burden on public companies and improve the efficiency and effectiveness of quarterly reporting while maintaining or enhancing investor protections. Specifically, the Commission focused its request for comment on a number of questions, primarily regarding the following:
All stakeholders are encouraged to respond to the Commission’s request within the comment period ending on March 21, 2019. The Commission will analyze the responses and will consider if it should propose an amendment to existing rules.
For more information on the SEC’s request for comments on earnings releases and quarterly reporting, watch our video.
The SEC’s amendments to certain of its disclosure requirements became effective for public companies on November 5, 2018. As part of the amendments, public companies are required to include in their quarterly reporting Form 10-Q an analysis of changes in stockholders' equity for the current and comparative quarter and year-to-date interim periods. The SEC did not prescribe a specified format to present this information. However, the disclosure must be presented in the form of a reconciliation either as a separate statement or in the footnotes.
The SEC previously published clarifying guidance indicating that the SEC staff would allow a public company to defer adoption of the amendment regarding changes in stockholders’ equity in its Form 10-Q until the first quarter beginning after November 5, 2018. As such, a calendar year-end public company must include the presentation of its changes in stockholders’ equity in its March 31, 2019 Form 10-Q.
For more information on the SEC’s amendments to update its disclosure requirements, see In brief 2018-21, SEC simplifies and updates disclosure requirements and In brief 2018-22, Implementing the recently adopted SEC rules.
In 2014, an EU Directive (the Directive) was enacted to provide greater transparency and accountability of companies by requiring certain non-financial disclosures. The Directive establishes minimum reporting standards for environmental, social, diversity, human rights, employee, anti-corruption, and bribery matters. The Directive requires certain minimum disclosures, which focus on a company’s impact and related policies in these areas, while allowing EU Member States to determine more detailed disclosure requirements.
The scope of the disclosure is determined by the EU Member State and generally applies to large companies, including subsidiaries of US companies, that meet the definition of a public interest entity (“PIE”). The EU Directive defines a large company as having more than 500 employees and either total equity of at least €20 million or revenue of at least €40 million. The EU Directive defines a PIE as a company that is:
The manner in which the final rules have been adopted into local regulations may differ for each Member State. Companies need to understand the specific Member State rules that apply to determine whether they are in scope, what disclosures are required, and where and how it is to be reported.
For more information, see the European Commission website on non-financial reporting.
Environmental, social, and governance (ESG)
ESG issues are a frequent topic of discussion among investors, directors, and management. For further information, refer to our publication, ESG: Understanding the issues, the perspectives, and the path forward. Additionally, our podcast, Sustainability reporting: 5 things you need to know, discusses the benefits of ESG reporting.
SEC Staff Accounting Bulletin (SAB) No. 74 requires a company to provide information on the status of its analysis and the impact that adoption of new standards is expected to have on its financial statements. With the adoption dates for the new current expected credit losses (CECL) standard and other new guidance approaching in 2020, companies’ SAB 74 disclosures should become more specific as the effective date of the new guidance nears.
Below is a summary of SAB 74 disclosures on the potential impact of adopting CECL in annual and quarterly filings of companies in the S&P 500 between January 1, 2019 and February 26, 2019.
As companies are preparing for the implementation of CECL, they should leverage lessons learned from the adoption of the new revenue and leases standards, as well as the following best practices to facilitate a successful implementation:
For more information on the new credit losses standard, refer to In the loop, Preparing for the new credit loss model, Chapter 7 of our Loans and investments guide, and In brief US2019-03, FASB proposes targeted relief upon adoption of the new credit loss standard.
The following identifies the FASB's recently released guidance, grouped by effective date for calendar year-end PBEs.
For further information on the new accounting guidance for public companies, including available PwC resources, refer to the following link.
For further information on the new accounting guidance for nonpublic companies, including available PwC resources, refer to the following link.
Partner, National Professional Services Group, PwC US
Director, National Professional Services Group, PwC US