By Joe Guage and Jeff Lezinski
From the Equipment Leasing and Finance Magazine
November / December 2017
There is just about one year to go until the new lease accounting standard, ASC 842, becomes the law of the land.
As companies prepare to implement the new standard, this is the time when theoretical concepts begin to intersect with practical application. To help us all prepare, the ELFA Financial Accounting Committee has created a Lease Accounting Resource Group (LARG) comprised of key industry lease accounting experts, including the Big Four accounting firms. The goal of the LARG is to solicit or identify technical accounting questions and issues related to the implementation of ASC 842 and provide ELFA members with opinions and guidance to consider in your implementation. Although these opinions are not authoritative and will not replace the guidance provided by the FASB, SEC or your auditors, it should provide insight into how members of the committee are considering some of the implementation questions associated with the standard.
At the time of publication, 62 items for consideration have been identified by and referred to the LARG. These topics span from initial direct costs, determining lease terms, to build-to-suit transactions. The resource group has already reviewed and provided feedback on several issues thus far, including the questions raised by ELFA members.
Financial statement preparers must consider all relevant contractual provisions, including options around renewals, termination options and any penalties. After considering all of this, preparers must include in the lease term all renewals that they consider to be reasonably certain to execute. In addition to those provisions embedded in the lease, a lessee should consider other factors such as economic impacts, technological obsolesce of the leased assets and other market-based factors as well as past practice and future business plans when assessing the expected lease term.
We believe that the answer to this is generally yes. ASC 818.104.22.168–10 provides definition and guidance regarding what qualifies as Initial Direct Costs. Paragraph 9 explicitly lists “Commissions” along with “Payments made to an existing tenant to incentivize that tenant to terminate its lease” as includable costs. Paragraph 10 of that section provides examples of specific costs that would not qualify as Initial Direct Costs.
The key distinction as to whether a cost qualifies as an Initial Direct Cost under the standard is based on whether the cost would have been incurred regardless of whether the lease was obtained, such as general overhead, costs associated negotiating lease terms or credit underwriting. These expenses generally represent sunk costs that will be paid whether the lease successfully closes or not and would generally not be included as an Initial Direct Cost. Conversely, if costs can be avoided in the event that the lease is not ultimately obtained, it would likely qualify as an Initial Direct Cost. Accordingly, commissions, even if they represent 100% of a person’s remuneration, may qualify as Initial Direct Costs to the extent that they are completely avoidable in the event that the lease doesn’t ultimately close.
Guidance around the specialized asset criteria is provided in paragraph 822.214.171.124 of ASC 842. Under that guidance, an entity should reconsider any contractual restrictions and practical limitations regarding the lessor’s ability to re-deploy the asset for another entity’s use. If there is a contractual restriction, this restriction must be substantive (i.e., enforceable) to meet this criteria. Alternatively, this criteria could be met if there is a practical limitation on the lessor’s ability to re-deploy the asset. Practical limitation might be that the lessor would incur a significant economic cost to modify the asset in order to remarket it or to uninstall, transport and re-install it at another lessee’s location. This might be the case where the leased asset has been materially customized for the current lessee’s business use.
This is a mere sampling of some the questions that the LARG has opined on as ASC 842 quickly approaches. While the LARG continues to prioritize the current list, the group recognizes that more and more organizations have gone beyond the initial “getting their feet wet” phases and have seriously started to prepare for implementation. This has prompted — and will continue to give rise to — additional unanswered questions and perceived issues not already contemplated by the LARG, with some leasing companies and lessees wondering where to turn. Therefore, to encourage additional participation in the formulation of the LARG issue list, the resource group along with ELFA has established a mechanism on the ELFA website for individuals to submit questions/issues for review and inclusion on the list.
In addition to working through the LARG list and enabling ELFA members to contribute in a more efficient manner, the group realizes that submission of a question/issue is only the first step. Therefore, the resource group is also currently exploring options for publication of opinions on specific issues to a wider audience. Stay tuned for future announcements and progress updates from the ELFA.
Joe Guage is CFO of First American Equipment Finance, an RBC/City National Company. Jeff Lezinski is Senior Vice President of Solutions Architecture for Odessa Technologies. Both are members of the Equipment Leasing and Finance Association (ELFA) Financial Accounting Committee.
The information in this article is a summary only. It may not address issues germaine to a particular company's lease accounting. This article should not be considered as providing an interpretation of the new rules or accounting advice, and readers should obtain their own independent accounting advice that takes into account all relevant aspects of a particular lessor's or lessee's business and products.