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Lease accounting reset - Presentation and disclosure · PwC's accounting podcast

0:00
SPEAKER_00: Thought Leadership from PWC's National Office.
0:06
SPEAKER_03: Hello, and welcome to PWC's Accounting Podcast.
0:10
SPEAKER_03: I'm Heather Horn.
0:12
SPEAKER_03: Today we're kicking off a new miniseries, this time focused on lease accounting, and we're starting things off with a topic that may seem straightforward on the surface, but may also carry major implications for the financial statements.
0:25
SPEAKER_03: And that's lease-related presentation and disclosure.
0:28
SPEAKER_03: From current versus non-current classification of lease liabilities to the treatment of lease incentives and sublease income, the decisions companies make in these areas can affect everything from key performance indicators to debt covenants.
0:44
SPEAKER_03: Joining me to explain what's required are two frequent podcast guests from our national office, Mark Jerusalem, a managing director, and Suzanne Stefani, a director, who both focus on lease accounting.
0:56
SPEAKER_03: So, Mark, Suzanne, thanks so much for joining me.
0:59
SPEAKER_03: And I'm so excited as always to have you guys on and to be talking about leases.
1:03
SPEAKER_03: It seems like every year this is one of the areas that we get the most questions, and it's also one of the areas of top interest for our publications and podcasts.
1:11
SPEAKER_03: So before we dive into the detail on presentation disclosure, Suzanne, can you just give us the highlights of what we'll be covering today?
1:19
SPEAKER_04: Yeah, thanks, Heather.
1:20
SPEAKER_04: Yeah, we're gonna start out today with questions we get on the three different financial statements.
1:24
SPEAKER_04: So starting with the balance sheet, we'll talk about questions we're seeing on current versus non-current presentation of the lease liability and how to present lease incentives to be received after the lease starts, where they go on the balance sheet.
1:38
SPEAKER_04: Then we'll move to the income statement, talk about finance lease, operating lease, kind of the basic presentation concepts there, talk a bit about variable rent and how to present that.
1:48
SPEAKER_04: And then we'll go to the cash flow statement.
1:51
SPEAKER_04: And we always get lots of questions there.
1:53
SPEAKER_04: So we'll kind of go over some things we see operating leases and how that works with the indirect method, non-cash events, prepaid rent, payments for leasehold improvements and lease incentives.
2:05
SPEAKER_04: And then we're gonna wrap it up with a discussion on the different disclosures that are required for leases annually and for interim as well.
2:13
SPEAKER_03: Perfect.
2:13
SPEAKER_03: So definitely a lot to cover, but perhaps we'll start things off with current for its non-current for lease liabilities.
2:18
SPEAKER_03: I feel like there's always so many questions in this area.
2:22
SPEAKER_03: So, Suzanne, what should companies be thinking about when it comes to how these amounts are calculated?
2:27
SPEAKER_04: Yeah, so there's actually no special classification rules for lease liabilities specifically.
2:33
SPEAKER_04: It really follows the same guidance as any debt instrument.
2:37
SPEAKER_04: So when you think about a lease liability, it's really set up like an amortizing loan, right?
2:42
SPEAKER_04: There's there's lease payments in the contract, and you set up an amortization schedule to figure out how much of that lease payment is principal and how much is interest.
2:52
SPEAKER_04: So for amortizing loans, we think there's three good options to follow when determining the current portion.
2:58
SPEAKER_04: So that's what we'll use for a lease liability.
3:01
SPEAKER_04: One is to take the present value of the next 12 months payments using the effective rate of the lease liability and making that current.
3:09
SPEAKER_04: Second option, just take the next 12 months payments of that lease and present them undiscounted.
3:16
SPEAKER_04: And third option is use your amortization schedule.
3:20
SPEAKER_04: So look at your lease liability amortization schedule and take the next 12 months of principal payments for the amortization schedule.
3:28
SPEAKER_04: So if I just go through a quick example, say I have a five-year lease and the contractual lease payments are$100 per year.
3:36
SPEAKER_04: Always due for simplicity at the end of the year, and discount rate, say 6%.
3:42
SPEAKER_04: So I'm at the end of year one of the lease.
3:44
SPEAKER_04: How much of the lease liability should be presented in current?
3:48
SPEAKER_04: So if I go with option one, that's taking the present value of the next year's contractual payments.
3:54
SPEAKER_04: I've got$100 due in the next year.
3:56
SPEAKER_04: If I present value it using 6%, it's$94.
4:00
SPEAKER_04: So that's gonna be my current liability under that option.
4:04
SPEAKER_04: Second option, if I have$100 due in the next year, my current liability is just gonna be$100, no discounting.
4:11
SPEAKER_04: And then the third option is using the amortization schedule.
4:15
SPEAKER_04: So when the lease liability is set up, I have this amortization schedule, and each payment is broken into principal and interest in that schedule.
4:23
SPEAKER_04: So again, the the um you guys listening out there can't see the schedule, but I have one here.
4:29
SPEAKER_04: So in my first my amortization schedule, when I'm looking at it, the$100 payment that I have that's gonna be due in the following year, so year two, it's broken between principal and interest.
4:41
SPEAKER_04: 75 principal, 25 interest using the 6% rate.
4:46
SPEAKER_04: So that means at the end of year one, the current liability is gonna be 75 as the principal.
4:52
SPEAKER_04: Hey, just to carry it forward, if I was going to classify it at the end of year two, it's not gonna be 75 again.
4:58
SPEAKER_04: In this case, it's gonna be 80 because the inch the amount's gonna change every year because it's um it's an amortizing loan.
5:05
SPEAKER_04: So it's gonna get um, it's gonna be lower in the earlier years because more payments attributed to interest in the time.
5:11
SPEAKER_04: So those are the three options.
5:13
SPEAKER_04: It is a policy election that companies should choose and then follow consistently.
5:17
SPEAKER_03: And do we see any practice that's more common than others?
5:22
SPEAKER_04: Um, I think that a lot of people use the option three where they use the amortization schedule.
5:28
SPEAKER_04: Um, but like I said, any options acceptable.
5:31
SPEAKER_03: Okay, they're very helpful and definitely um it's an important area to make sure you get that classification correctly.
5:37
SPEAKER_03: So then let's move on and shift our attention to lease incentives.
5:41
SPEAKER_03: So, in many real estate leases, as we've talked about on many prior podcasts, the lesser provides the tenant with an allowance to build out the space or some other incentive, but let's stick with that.
5:52
SPEAKER_03: This is usually reimbursed after the work is done.
5:55
SPEAKER_03: And then this is often after the lease commencement date.
5:58
SPEAKER_03: So if the lessee's actually expecting to receive a payment, how would that be reflected on the balance sheet?
6:05
SPEAKER_03: So, Mark, I'll turn to you.
6:07
SPEAKER_01: Uh yes, Heather.
6:08
SPEAKER_01: This is um a really common transaction that we often see.
6:12
SPEAKER_01: And I will preface this all by saying there is diversity in practice.
6:17
SPEAKER_01: The leases standard doesn't expressly address this.
6:20
SPEAKER_01: So while today we're talking about presentation and disclosure, I do have to get into the accounting a little bit so we can understand why there's different ways to present it.
6:30
SPEAKER_01: So, if like the example that you just gave, right, I have let's say a five-year lease of real estate or whatever the term is, and I'm going to remodel the space and I'm going to receive up to a million dollars back from the Lessor as a lease incentive.
6:44
SPEAKER_01: Once I submit my receipts, then I've done the work.
6:47
SPEAKER_01: Okay.
6:48
SPEAKER_01: And let's just pretend that I've got a year to submit the receipts and get reimbursed, right?
6:53
SPEAKER_01: So the question is, you know, from an accounting perspective, how do I account for that?
6:58
SPEAKER_01: So the diversity in practice is really this, right?
7:01
SPEAKER_01: Some people might say, well, as soon as I do the work, I would say I've earned part of that amount, and I would record a receivable on the books.
7:11
SPEAKER_01: All right.
7:11
SPEAKER_01: That's one practice.
7:13
SPEAKER_01: Frankly, we prefer the other practice, which is to include the million dollars as a negative amount in your lease liability, right?
7:20
SPEAKER_01: So in your lease liability, you would have the present value of all your lease out payments, right?
7:25
SPEAKER_01: Your cash, your out your cash outflows, excuse me.
7:28
SPEAKER_01: And then you would offset that by the million dollars that you expect to get, let's just say, in one year as a cash inflow, generally not as a separate receivable.
7:37
SPEAKER_01: We're actually going to have a separate podcast where we talk about what is or isn't a variable rent and how to think about those things.
7:44
SPEAKER_01: But sometimes people ask about lease incentive.
7:46
SPEAKER_01: Hey, isn't that just a variable rent that I shouldn't even record at all until it's resolved?
7:54
SPEAKER_01: And there's until I've spent all the money and the lessor has approved the amounts, and he tells me, okay, we'll send you a check next month.
8:00
SPEAKER_01: You know, should I not record it then?
8:02
SPEAKER_01: I'll just tell you, stay tuned for that podcast.
8:04
SPEAKER_01: But we think of these generally as fixed payments, not as variable payments.
8:08
SPEAKER_01: Maybe they're in substance fixed payments.
8:10
SPEAKER_01: And that's why there's a little bit of diversity in practice in terms of how to account for these.
8:14
SPEAKER_03: So, Mark, can I ask a question before we go on and talk a little bit about classification?
8:20
SPEAKER_03: And, you know, the way you've described this, it really doesn't matter if you're actually going to get a payment from the lessor or maybe a reduction in rents.
8:28
SPEAKER_03: Is that true?
8:29
SPEAKER_03: Or am I jumping ahead to another discussion?
8:33
SPEAKER_01: You're jumping ahead to another discussion because if you're talking about something that isn't a payment, it doesn't really affect, let's say, the question that we're talking about right now, a current liability or current asset, because there is no payment to account for.
8:46
SPEAKER_03: All right.
8:46
SPEAKER_03: So you're saying if it's just a future rent reduction, that would be something different.
8:50
SPEAKER_03: This is solely the case where they're actually going to, I'll say, cut you a check.
8:54
SPEAKER_01: That's right.
8:55
SPEAKER_01: The diversity is what do I do with that cash inflow, right?
8:59
SPEAKER_01: Because in a lease, it's always the lessee is paying the lessor.
9:02
SPEAKER_01: You don't typically have cash inflows from the lessor.
9:05
SPEAKER_01: Yes.
9:05
SPEAKER_01: So that's the weird thing we're talking about, not weird, but that's the thing we're talking about here.
9:08
SPEAKER_03: Okay.
9:09
SPEAKER_03: So then in these circumstances, and if you have the case that you are treating this as an offset, the incentives as an offset to the lease liability, uh, and I'm expecting to get this payment within the next 12 months, because that's what you've said, then how does that impact the classification between current and non-current?
9:29
SPEAKER_01: Right.
9:29
SPEAKER_01: So that's where we've gotten some interesting questions.
9:31
SPEAKER_01: That frankly, when the standard first came out, we weren't even thinking about these questions.
9:35
SPEAKER_01: So let's say that the normal lease payments are$800,000.
9:38
SPEAKER_01: Well, SE has to pay$800,000 a year, but in that first year, they're going to get a one-time cash inflow of a million.
9:44
SPEAKER_01: So if I just stopped right there, what is the current lease liability?
9:47
SPEAKER_01: Is it the$800,000 you're going to pay out?
9:50
SPEAKER_01: Is it net$200,000 back?
9:53
SPEAKER_01: I wouldn't think that a current lease liability can ever be a positive number.
9:57
SPEAKER_01: It has to be a negative number.
9:58
SPEAKER_01: So we think in that fact pattern where the incentive is in excess of the lease liability, you would have no current lease liability at all.
10:08
SPEAKER_01: Meaning all the lease liability associated with that lease would all be non-current, right?
10:12
SPEAKER_03: All right.
10:13
SPEAKER_03: So, Mark, that's helpful and makes sense because in our example we just talked about we have one lease, and so we can offset that lease payment.
10:21
SPEAKER_03: However, in many cases, the you know, the entity will have multiple leases on the books, and that will all be amalgamated in that current liability.
10:30
SPEAKER_03: So in that case, can I use the excess debit to reduce the overall liability related to other leases?
10:37
SPEAKER_01: Right.
10:38
SPEAKER_01: Well, as soon as you asked the question, the answer probably became intuitive that of course we we can't offset the receivable that we have with from one arrangement to the liabilities we have with another arrangement.
10:50
SPEAKER_01: So for that one lease, the lease liability would be zero.
10:53
SPEAKER_01: And we don't get to use the 200,000 excess to reduce the lease liability of other leases.
10:59
SPEAKER_01: So even though it shows up in the same line item in the balance sheet, when you're figuring out your current liability, any leases that have that sort of net debit position, you kind of have to segregate them to the side.
11:10
SPEAKER_01: Figure out your current lease liability on the others, and that one would be zero.
11:14
SPEAKER_03: So then, Mark, that seems to your point quite intuitive, but do we actually get this question?
11:20
SPEAKER_01: So I'm not going to lie and say this is a frequent flyer question.
11:24
SPEAKER_01: Where it comes up, of course, is where the lease incentive is quite large and um or there's some other rent deferral with very low actual rents in the first year.
11:33
SPEAKER_01: We have had that question, and sometimes, unfortunately, that you know it's been a material situation.
11:39
SPEAKER_03: All right.
11:39
SPEAKER_03: It's very helpful.
11:40
SPEAKER_03: So let's move on then uh to the income statement and maybe walk through the presentation.
11:46
SPEAKER_03: Mark, if I can stick with you, can you walk us through how lessees should present the expenses associated with the lease on the income statement?
11:55
SPEAKER_01: Sure.
11:55
SPEAKER_01: So we're all familiar there are finance leases and operating leases, right?
12:00
SPEAKER_01: And they have to be presented separately.
12:02
SPEAKER_01: So let's just hit finance leases first, even though operating leases are certainly more common, but we'll get finance leases out of the way.
12:07
SPEAKER_01: So finance leases are presented in the income statement the same way that any, you know, financed purchase of PPE would be presented.
12:18
SPEAKER_01: So the amortization of the right-of-use asset would be shown together with other amortization or depreciation of fixed assets.
12:25
SPEAKER_01: And the interest portion on the lease liability would be shown together with other interest expenses wherever that is.
12:33
SPEAKER_01: One question that we frequently get is well, leases often have some variable payments as well.
12:41
SPEAKER_01: How do we think about a variable payment, right, when there's both an interest and a depreciation or amortization factor?
12:49
SPEAKER_01: So we generally think, you know, if you think about a typical lease, the lessor wants a guaranteed return for his investment, right?
12:56
SPEAKER_01: There typically will be significant fixed payments.
13:00
SPEAKER_01: When there are variable payments on top of those fixed payments, we typically think of that as just incremental interest, right?
13:07
SPEAKER_01: So our bias, it does depend on facts and circumstances, but our bias is that variable lease expense and a finance lease would typically be incremental interest expense.
13:17
SPEAKER_01: Now, in those strange fact patterns where maybe there are no fixed rents, so all the payments are variable.
13:24
SPEAKER_01: I we do admit that it's kind of hard to show interest expense when there's no lease liability on the balance sheet to attract that interest expense.
13:32
SPEAKER_01: So in that fact pattern, again, not so common, we would show the variable lease payments as really just rent expense, and we'd show them in operating expenses.
13:43
SPEAKER_03: All right.
13:44
SPEAKER_03: So sounds like you need some good disclosure in that case.
13:46
SPEAKER_03: Uh how about operating leases then, Mark?
13:49
SPEAKER_01: So operating leases, we do not separately show the interest and the amortization portions of the expense.
13:56
SPEAKER_01: We just show a single lease expense.
13:58
SPEAKER_01: And that would be within income from operations, um, typically on a straight line basis.
14:03
SPEAKER_03: All right.
14:04
SPEAKER_03: And then how about the case where um I know this does occur, where you get into where the right of use asset actually is impaired, then what would that presentation be?
14:14
SPEAKER_01: Right.
14:14
SPEAKER_01: So when a right of use asset is impaired, um, the the way the lease expense is calculated is then changed, right?
14:22
SPEAKER_01: From an accounting perspective, it's accounted for more like a finance lease is accounted for.
14:27
SPEAKER_01: So then we have straight line amortization and we do have an interest portion.
14:33
SPEAKER_01: It's accounted for similar to a finance lease, but nevertheless, when it's presented on the income statement, it's presented as a single lease expense within income from operations.
14:44
SPEAKER_03: So, Mark, that makes sense for single lease expense, but what about the impairment charge itself?
14:50
SPEAKER_03: If the lessee writes down the right of use asset, is that charge then included with the lease expense on the income statement?
14:56
SPEAKER_01: Right.
14:56
SPEAKER_01: I'm glad you brought that up.
14:58
SPEAKER_01: No, it's not.
14:58
SPEAKER_01: It's not part of the rent expense.
15:00
SPEAKER_01: That would be an impairment charge, just like any other fixed asset impairment charge.
15:04
SPEAKER_01: So wherever you put that is where you put the impairment charge.
15:07
SPEAKER_03: All right.
15:08
SPEAKER_03: So let's switch up to something else that we've talked about previously on this podcast, and that's related to subleases.
15:14
SPEAKER_03: And I think that was something we've done a number of episodes on over the years.
15:19
SPEAKER_03: Um, how is sublease income presented in the financial statements?
15:23
SPEAKER_01: Right.
15:23
SPEAKER_01: So this is just a repeat of things we've talked about before, right?
15:27
SPEAKER_01: The leases guidance definitely requires that we um disclose sublease income on a gross basis.
15:35
SPEAKER_01: So we'd have sublease income and the rent expense associated with that property.
15:40
SPEAKER_01: But it doesn't explicitly address where this goes on the, you know, presented on the income statement.
15:44
SPEAKER_01: Obviously, gross is always acceptable, right?
15:47
SPEAKER_01: You're giving the most information.
15:48
SPEAKER_01: Even if you put it net on the income statement, you still have to disclose it.
15:52
SPEAKER_01: But um, we would not object to somebody that wants to net the um rent expense against the sublease income and show a single line item.
16:02
SPEAKER_01: Particularly, it makes sense if the only reason you're subletting something is to mitigate and to reduce your occupancy expenses, right?
16:09
SPEAKER_01: I would just caveat that if this is your business, right?
16:12
SPEAKER_01: If you're renting in a building in order to rent office spaces to temporary workers, right?
16:17
SPEAKER_01: So you have lease expense on the whole building, sublease income on the pieces of the building.
16:22
SPEAKER_01: Well, that's your business.
16:23
SPEAKER_01: Then you should always show it gross, right?
16:25
SPEAKER_01: All right, but that's look at the facts and circumstances.
16:27
SPEAKER_03: Relatively rare case, I would say.
16:29
SPEAKER_01: That's right.
16:29
SPEAKER_03: All right.
16:30
SPEAKER_03: So then that's helpful for the income statement.
16:32
SPEAKER_03: Susan, go back to you for the cash flow statement.
16:35
SPEAKER_03: And maybe before we get into some details, do you want to give us the overall presentation?
16:40
SPEAKER_04: Yeah, sure.
16:41
SPEAKER_04: Thanks.
16:41
SPEAKER_04: So I'll start with finance leases.
16:43
SPEAKER_04: So finance leases, the cash payments are just treated like debt payments.
16:48
SPEAKER_04: So sort of like I was talking about for current versus non-current classification.
16:52
SPEAKER_04: So basically, any payments that are for principal based on the amortization schedule would be considered financing outflows.
17:00
SPEAKER_04: And then any payments that are considered interest would be operating.
17:04
SPEAKER_04: So that's a little more straightforward.
17:06
SPEAKER_04: Um, operating leases, well, the classification itself is straightforward.
17:12
SPEAKER_04: All payments for operating leases go through operating cash flows.
17:15
SPEAKER_04: So that's that's easy.
17:17
SPEAKER_04: But we do still get some questions on how that works with the indirect method.
17:22
SPEAKER_04: And like like we've said before, most people, I would say, do the indirect method.
17:27
SPEAKER_04: So questions come up on how the amounts related to the lease payments and the single lease expense should be presented when you're looking at the reconciliation of net income to operating cash flows.
17:38
SPEAKER_04: So there's multiple ways to look at it.
17:40
SPEAKER_04: I'll start with what we think is the best way to do it.
17:44
SPEAKER_04: And that's what we call a two-line approach.
17:46
SPEAKER_04: And that's following how it's shown in the balance sheet, right?
17:49
SPEAKER_04: There's two balance sheet line items, lease liability and right of use asset, that are expect, sorry, impacted by the single lease expense.
17:57
SPEAKER_04: So if you take that approach, you'll have line first line would add back the right of use asset amortization.
18:04
SPEAKER_04: And then the second line that I would show would be subtracting the change in the lease liability that related to the lease payments, less the interest piece of the single lease expense.
18:15
SPEAKER_04: So, for example, if I had a lease and in that period I had a cash lease payment of 80.
18:21
SPEAKER_04: And let's just say the single lease expense was 100 and it was made up of$70 of ROU asset amortization and$30 of interest.
18:30
SPEAKER_04: Like Mark said, it's all one line in the income statement, but it does break up for the accounting.
18:36
SPEAKER_04: So I'm looking at my reconciliation to net income.
18:39
SPEAKER_04: I'd have single lease expense of$100 as a deduction from net income, right?
18:43
SPEAKER_04: And the top line there, I'd add back my ROU asset amortization of$70, and I'd have a decrease for the change in lease liability of$50.
18:52
SPEAKER_04: So that's the$80 payment less the$30 interest.
18:56
SPEAKER_04: And that gets me to having$80 in operating cash flows.
19:00
SPEAKER_04: That's what we think is the best way to show it.
19:02
SPEAKER_04: There is diversity in practice, and some companies will continue since you know the old leases guidance, they used to show it as one line, right?
19:11
SPEAKER_04: Add add back, and that's still acceptable.
19:14
SPEAKER_04: So in my case, that would just be an add back of 20 in my uh my example there to get you still get you to the 80 cash flows.
19:22
SPEAKER_03: So, Suzanne, that's helpful, and that's sort of the base case.
19:25
SPEAKER_03: But now let's go to a few specific cases, including where if I'm the lessee and I'm making a cash payment as part of either a modification or a termination, how would I present that?
19:38
SPEAKER_04: Yeah, so that's gonna be just presented like any other lease payment.
19:42
SPEAKER_04: Meaning if you make a payment to terminate or modify an operating lease, it'll be operating, just basically following the guidance that I um talked about earlier.
19:50
SPEAKER_04: So it's no different.
19:52
SPEAKER_04: Just any, it's like a lease payment.
19:54
SPEAKER_04: All right, and then how about prepaid rent?
19:56
SPEAKER_04: Yeah.
19:56
SPEAKER_04: Okay, prepaid rent might be a little different.
19:59
SPEAKER_04: Um, so prepaid rent, you're paying that, right, before you have a right of use asset recorded or lease liability, you're paying it before commencement, right?
20:09
SPEAKER_04: So questions come up on where do I put that on the cash flow statement?
20:13
SPEAKER_04: The answer is it depends.
20:14
SPEAKER_04: It depends on what the expected lease classification is gonna be.
20:19
SPEAKER_04: So if you have clear evidence that when when you make that payment, it's going to be a finance lease.
20:25
SPEAKER_04: Like maybe it's easy, you know, that title to the asset transfers at the end of the lease term or something like that.
20:31
SPEAKER_04: Then we think there's there's two, there's no specific guidance, but we think two views can work here.
20:36
SPEAKER_04: One would be put it in investing, right?
20:39
SPEAKER_04: Because under this view, it's like you made a prepayment prepayment, it's ultimately gonna end up as an finance lease right of use asset.
20:48
SPEAKER_04: And one could think about a finance lease right of use asset as a productive asset.
20:52
SPEAKER_04: And when you buy a productive asset, that's investing.
20:55
SPEAKER_04: So that's one view.
20:56
SPEAKER_04: Another view is when you make that payment, put it into financing.
21:01
SPEAKER_04: Having a finance lease, it's just like having debt, right?
21:04
SPEAKER_04: And any payments, no matter the timing of when they're made, they're just debt payments.
21:09
SPEAKER_04: So we so in the under that view, financing makes sense.
21:12
SPEAKER_04: Now there's no liability at that time, so we wouldn't have to break it in between interest and principal, it just would just be financing.
21:18
SPEAKER_04: So both of those views are acceptable there.
21:21
SPEAKER_04: So it's just a policy you apply.
21:23
SPEAKER_04: Now, if you don't know if it's gonna be a finance lease or not, you don't have clear evidence, or it's an operating lease, you know that.
21:30
SPEAKER_04: Then any payment you make there, it's going to be operating.
21:33
SPEAKER_04: So we don't see some say, hey, but same concept, right?
21:36
SPEAKER_04: You're putting an ROU asset on the books.
21:38
SPEAKER_04: Isn't an ROU asset for an operating lease a productive asset?
21:42
SPEAKER_04: We don't see it that way.
21:43
SPEAKER_04: And we we don't see it as the same same there.
21:46
SPEAKER_03: All right.
21:47
SPEAKER_03: That's um helpful and obviously this is the easier to deal with if you already know how the lease is going to be classified.
21:53
SPEAKER_03: Right.
21:53
SPEAKER_03: So then, Suzanne, let's go back and ask another question on lease classification on the capital.
22:00
SPEAKER_03: Or the classification on the cash flow statement.
22:02
SPEAKER_03: And this is going to rewind to our discussion we had on the lease incentives.
22:07
SPEAKER_03: So in the example that Mark talked about, the lessee is going to get$1 million to put in uh leasehold improvements, so their own assets after the lease commencement.
22:17
SPEAKER_03: And so in this case, let's assume the lessee spends the 1 million in one period and then it submits the receipts and is reimbursed in the same period.
22:28
SPEAKER_03: What would happen?
22:29
SPEAKER_04: Yeah.
22:29
SPEAKER_04: Okay.
22:29
SPEAKER_04: So and I'm going to assume it's an operating lease.
22:31
SPEAKER_04: It's probably real estate or something like that.
22:33
SPEAKER_04: Okay.
22:34
SPEAKER_04: So step one, the lessee's buying their own assets.
22:37
SPEAKER_04: I think you said for a million dollars.
22:39
SPEAKER_04: When they buy their own assets, they're just buying PPE, right?
22:42
SPEAKER_04: So just like any PPE purchase, the million dollars is going to be an investing outflow.
22:47
SPEAKER_04: And now step two, the lessor is reimbursing the lessee for those assets.
22:52
SPEAKER_04: That's just an operating inflow, right?
22:55
SPEAKER_04: It's like Mark said, it's all probably going to be part of the lease liability.
22:59
SPEAKER_04: It's just like a negative lease payment.
23:01
SPEAKER_04: So it's going to be put in operating.
23:03
SPEAKER_04: One thing, just want to uh caution, don't net the inflow and outflow.
23:08
SPEAKER_04: Well, clearly they're going to be in different categories, but sometimes I think the inclination is to be like, yeah, I just paid a million dollars, but I got reimbursed.
23:15
SPEAKER_04: So maybe I just don't show anything.
23:18
SPEAKER_04: No, because it it's they're two different things.
23:20
SPEAKER_04: One's the purchase of assets, one's getting reimbursed from the lessor.
23:24
SPEAKER_03: So then, Suzanne, what about in the same case, but the lessor is actually paying the invoices directly?
23:31
SPEAKER_03: So on the lessee, I you know make my purchases and then I send the invoices to the lesseur to pay.
23:37
SPEAKER_03: Does that change anything?
23:39
SPEAKER_04: Okay, yeah.
23:39
SPEAKER_04: This is a common question we get.
23:42
SPEAKER_04: Often, the even though the lessee owes the vendor the money for the their own assets they just purchased, they're also owed money back, right, from the lesseurs.
23:53
SPEAKER_04: So they'll ask the lessor to just pay the vendor directly, right?
23:56
SPEAKER_04: It's just easier.
23:58
SPEAKER_04: Well, when that happens, the lessor is making a payment to the vendor on behalf of the lessee.
24:04
SPEAKER_04: So we have to think about this concept we call constructive receipt and disbursements.
24:10
SPEAKER_04: Um, basically, when you have three parties there and a person in the middle is acting as agent and making that payment on your behalf, you should show it on the cash flow statement as if you made the payment yourself.
24:22
SPEAKER_04: So in this case, when the lessor pays a million dollars to the vendor, we're gonna show that outflow as our own investing outflow, but we didn't get any cash, right?
24:32
SPEAKER_04: So we're gonna have to show that million dollars coming in for the incentive and operating.
24:37
SPEAKER_04: So it's just you shouldn't get a different answer on your cash flow statement just because you had an agent go in between and do that payment.
24:45
SPEAKER_04: And in this case, it was probably just for convenience.
24:47
SPEAKER_03: All right.
24:48
SPEAKER_03: That's definitely something to pay attention to and make sure that things don't get improperly net off.
24:53
SPEAKER_03: So before we move on from the cash flow statement, then let me ask you one more question because obviously often with leases, you also can have non-cash transactions.
25:02
SPEAKER_03: So we've gone through a lot of examples here where there are payments or otherwise being made.
25:07
SPEAKER_03: But what about in a case where, for example, you have a new lease or you change your right-of-use asset because of a lease reassessment or you made a modification or otherwise?
25:17
SPEAKER_03: How are those non-cash items handled for the cash flow statement?
25:21
SPEAKER_04: Yep.
25:22
SPEAKER_04: So I think straightforward for a finance lease, you're gonna disclose them because they're non-cash transactions related to a financing.
25:30
SPEAKER_04: And that's right out of the even out of the cash flow guidance.
25:33
SPEAKER_04: But what's kind of interesting for an operating lease, normally you don't disclose non-cash operating transactions based on the cash flow guidance.
25:40
SPEAKER_04: But um, when the leases guidance came out, this newer leases guidance came out, they actually do require these changes to be disclosed as non-cash transactions, even for operating leases.
25:52
SPEAKER_04: Um we think when you have these, like for example, your lease liability goes up because you modified the lease and it's a non-cash thing, right?
26:03
SPEAKER_04: You put bring up the lease liability and the right-of-use asset.
26:06
SPEAKER_04: We want to show that.
26:07
SPEAKER_04: I think the best approach is not show that in the reconciliation to net income as a change, just disclose it.
26:13
SPEAKER_03: All right.
26:13
SPEAKER_03: So it's Suzanne, that's helpful.
26:15
SPEAKER_03: Definitely a lot to think about from a cash flow statement perspective.
26:19
SPEAKER_03: And again, I know these are just the highlights we hit there, and people should definitely look to the lease guide for more information.
26:25
SPEAKER_03: But why don't we round out this podcast and talk about disclosures?
26:29
SPEAKER_03: And for this discussion, Mark, I'll go back to you if you want to give some sort of overall thoughts and then we can dig into the detail.
26:36
SPEAKER_01: Yeah, thank you.
26:37
SPEAKER_01: Um, so there are a fair number of disclosures in topic 842, and they're both qualitative and quantitative.
26:44
SPEAKER_01: And the one thing I would say, we'll talk about the qualitative ones first, but the one caveat I would give is sometimes we see that the qualitative disclosures become very boilerplate.
26:55
SPEAKER_01: It's almost as if somebody wrote down the sentences out of 842 and put them in their qualitative disclosures.
27:00
SPEAKER_01: And I would just, you know, caution people, try to make them useful to readers.
27:05
SPEAKER_01: So if I give a silly example, say that I have a company that has a bunch of IT equipment that is leased for two years, they've got office space leased for five years, and they've got a ground lease that they've leasing for 50 years because they built an office building on top of it.
27:20
SPEAKER_01: I don't think it would be too helpful to tell the readers that our lease terms range from two to 50 years, and I have renewal options from one year to 10 years.
27:29
SPEAKER_01: Like give us a little color or break it down into some kind of categories.
27:33
SPEAKER_01: So, with that aside, um the qualitative disclosures, we have to give a general description of our leasing arrangements, which is kind of what I was just talking about.
27:42
SPEAKER_01: If our leases have variable lease payments, then we're supposed to disclose the basis and terms upon which that variability is determined, right?
27:50
SPEAKER_01: The types of variability, et cetera.
27:52
SPEAKER_01: Um, if there are extension options or termination options, which are really kind of two flavors of the exact same thing, we should talk about those.
28:00
SPEAKER_01: If we have any residual value guarantees, right?
28:03
SPEAKER_01: And another one that is often overlooked today, perhaps less so under the old leases guidance, is that quite often leases will have debt-like covenants embedded within the leases, or they'll be cross-collateralized to other debt arrangements that have covenants.
28:21
SPEAKER_01: So those types of things should also be disclosed.
28:24
SPEAKER_01: Um, another thing that should be disclosed either in the leases footnote or along with your commitments footnote is if I have entered into leases, meaning I have lease inception, but the lease doesn't commence until a future period.
28:36
SPEAKER_01: So we should talk about leases that have been entered into but have not yet commenced.
28:41
SPEAKER_01: And then finally, um qualitatively, we should also talk about whether there were any significant judgments or assumptions that were needed to get to the conclusions.
28:50
SPEAKER_01: So this often comes up with companies that have significant embedded leases, right?
28:55
SPEAKER_01: Um sometimes it's obvious that you have an embedded lease, sometimes you had to make some assumptions.
28:59
SPEAKER_01: And you know, we're gonna have a podcast on embedded leases, but like who really has the right to direct the use of the of the manufacturing equipment as an example?
29:08
SPEAKER_01: And if you do have an embedded lease, you know, what are the components in that lease, right?
29:13
SPEAKER_01: Because, all right, so those are the types of things that you have to think about.
29:17
SPEAKER_01: Um, the standard also requires that we disclose how we came up with our discount rates.
29:23
SPEAKER_01: So think about disclosing what you used as like a base reference rate and then what kinds of adjustments you had to make to those rates.
29:31
SPEAKER_01: Or specifically, if you're using the rates of a parent or a group, right?
29:37
SPEAKER_01: Because you've determined that that's appropriate, even though you're the legal entity that has entered into the lease, we should talk about those fact patterns where we're using a group rate.
29:47
SPEAKER_03: So, Mark, before we move on then to the quantitative disclosures, let me ask a question because you sort of prefaced all of this by saying don't be too boilerplate, don't smash too many different pieces of disclosure together.
30:00
SPEAKER_03: But so then from a practical point of view, do you typically see these disclosures separately for each different lease?
30:07
SPEAKER_03: Or how do companies tend to approach this?
30:11
SPEAKER_01: I'll be frank, from a practical uh perspective, we often do see boilerplate of disclosures.
30:18
SPEAKER_01: The one thing I would say that people that have asked us questions that have been doing is specifically when people have uh a new or significant lease transaction, that is the reason they're asking us questions because they're different from what they've had before.
30:33
SPEAKER_01: And so um sometimes, and without getting into too many specifics, but for example, if I had a government grant that is altering how we account for things or whatnot, you know, if you have a significant enough transaction that people should understand it, right?
30:47
SPEAKER_01: Similar to the types of disclosures you might have in an MDNA, you know, so then talk about that one.
30:52
SPEAKER_01: But I I do admit that for many companies, if you're just leasing equipment in office space for five years, there's there's not that much to talk that much to talk about, right?
31:01
SPEAKER_01: I'm just saying that just make the disclosures something that that people can understand what it is that you're doing.
31:08
SPEAKER_03: Yeah.
31:08
SPEAKER_03: So then if there's maybe different types of leases or you know, you have buildings and equipment to separate them, or or otherwise, at least try to think about that.
31:16
SPEAKER_03: All right, that's helpful.
31:17
SPEAKER_03: So then that was on qualitative.
31:20
SPEAKER_03: Now let's move on to quantitative.
31:22
SPEAKER_01: Yep.
31:22
SPEAKER_01: So a fair amount of quantitative disclosures are required.
31:25
SPEAKER_01: So we have um I again I'm gonna preface this by saying if you have both operating leases and finance leases, everything I'm about to say, you should disclose the two amounts separately from each other.
31:37
SPEAKER_01: Okay.
31:38
SPEAKER_01: So separately from each other, lassees should disclose finance lease costs, operating lease costs, including variable lease costs, and any short-term lease costs that didn't go through the lease liability.
31:49
SPEAKER_01: Also, how much cash did I pay for amounts that were included in my lease liabilities?
31:55
SPEAKER_01: The non-cash information that Suzanne talked about a couple minutes ago.
31:59
SPEAKER_01: No, lease liabilities are arising because I obtained a right of use asset.
32:03
SPEAKER_01: We have to disclose the weighted average lease term and the weighted average discount rate that's in my leases.
32:10
SPEAKER_01: Um, we have to have a maturity analysis separately for my operating leases and finance leases that shows all of the payments for each of the next five years and then a lump sum for the payments thereafter.
32:22
SPEAKER_01: All these payments are not discounted.
32:24
SPEAKER_01: And then we have a reconciliation to the discounted payments that are on your balance sheet.
32:30
SPEAKER_01: Um and as Suzanne talked about a few minutes ago, you know, this is not necessarily intuitive.
32:37
SPEAKER_01: The amount that you're showing as a current lease liability, right, may not be that first line item in your five-year maturity table.
32:45
SPEAKER_01: That would only be the case if you chose one of the options that was for the undiscounted cash flows, then it might be the same.
32:51
SPEAKER_03: All right.
32:51
SPEAKER_03: And then you started this off by talking about your lease cost.
32:55
SPEAKER_03: And I think on the surface, people would just presume that's going to align with the income statement, but I know that's not always the case.
33:01
SPEAKER_03: So what are some of the things that could cause differences there?
33:04
SPEAKER_01: Right.
33:04
SPEAKER_01: So the disclosure requirements actually use the word lease cost as opposed to lease expense, um, specifically recognizing that, especially for manufacturers, often the lease cost then does not appear as lease expense in the income statement because it's part of your standardized cost system, it's part of your overhead that might get allocated to inventory.
33:26
SPEAKER_01: In some cases, it might get included in a PPE that you're building.
33:30
SPEAKER_01: Whatever the case is, there may be circumstances where some of it's capitalized on the balance sheet, and then we'll bleed through through cost of goods sold.
33:38
SPEAKER_01: So for all these quantitative disclosures, think of the lease costs regardless of whether you've capitalized them or not.
33:45
SPEAKER_03: All right.
33:46
SPEAKER_03: So, Mark, one of the things Suzanne, when she was setting up this podcast, she mentioned that we were talking about both annual and interim disclosures.
33:54
SPEAKER_03: So, are all of these disclosures we just talked about, are those all only annual, or what is required on an interim basis?
34:02
SPEAKER_01: So I guess the good news here is that you're not required to put any of these disclosures necessarily in your interim financial statements.
34:09
SPEAKER_01: Okay.
34:10
SPEAKER_01: So topic 270 covers interim financial statements.
34:13
SPEAKER_01: There's actually no specific interim financial statement guidance within 842 at all.
34:18
SPEAKER_01: So we just look to the guidance in 270.
34:20
SPEAKER_01: Okay, topic 270, um, on interim reporting.
34:24
SPEAKER_01: And just as an aside, topic 270 is one of the things that is being discussed by the FASB right now.
34:30
SPEAKER_01: So just pay attention to that, right?
34:32
SPEAKER_01: Um, but getting back to this, so I as long as things are consistent with your last annual report, you don't have to disclose any particular disclosures in your quarters.
34:43
SPEAKER_01: Obviously, if something significant has changed or has happened, meaning significant new leases or modifications or things, if that information that was in your annual report is no longer the best reflection of your current commitments, then you should probably have some interim disclosures, which is consistent with other thoughts on 270 in general.
35:03
SPEAKER_03: All right.
35:03
SPEAKER_03: And so then, Mark, just taking a step back, and I'll ask both of you guys this question.
35:08
SPEAKER_03: So we've run through the financial statements as well as from a disclosure perspective.
35:12
SPEAKER_03: When you're talking to companies or engagement teams that have questions about these topics, is there any sort of overarching advice that you would give?
35:22
SPEAKER_01: Well, um, I guess as far as presentation and disclosure, we have an entire chapter in our financial statement presentation guide, our FSP guide.
35:31
SPEAKER_01: I think it's chapter 14.
35:33
SPEAKER_01: So you could uh take a look at that.
35:35
SPEAKER_01: It's very comprehensive.
35:36
SPEAKER_01: And of course, we have our leases guide that talks about more of the accounting for leases and as well as some of these nuances that we've been talking about, such as the lease incentives and you know, things of that nature, you could find in there.
35:50
SPEAKER_03: All right.
35:50
SPEAKER_04: And Suzanne, from you, any final words of wisdom?
35:53
SPEAKER_04: Yeah, I guess just make sure you have a really good understanding of the lease contract and all the payments in there because you're gonna have to make these detailed disclosures, like Mark said.
36:02
SPEAKER_04: You'll have to understand how everything works for the cash flow statement and yeah, and just really dig into the contract.
36:08
SPEAKER_03: All right.
36:09
SPEAKER_03: Well, as always, such a pleasure to talk to the two of you.
36:12
SPEAKER_03: Thanks so much for joining me today.
36:14
SPEAKER_03: Thanks.
36:14
SPEAKER_01: Thank you.
36:15
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36:38
SPEAKER_02: From Thought Leadership at PWC, I'm Heather Horn.
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