By Denise Lugo
Companies filing for bankruptcy could find adopting new lease accounting changes unpleasant, many of which require them to compile huge piles of data when staff with knowledge of the topics might have left, according to remarks made during a joint meeting of FASB’s private and small public company advisory boards.
The loss of institutional knowledge stemming from staff departure adds major challenges to implementing the rules, the discussions on December 17, 2019, indicated.
“My company filed for bankruptcy in September and we’re liquidating, but we implemented lease accounting in Q1 and it was the most painful thing I’ve ever gone through, more so because staff left,” Shannon Greene, senior vice president and controller at Fred’s Inc., a discount retail and pharmacy chain headquartered in Memphis, Tennessee. Fred’s in September announced it filed for chapter 11 bankruptcy and had started liquidating all of its retail locations.
“We lost a lot of institutional knowledge, where the leases were and how do we find the copier contract – all of that staff,” said Greene, also a member of the FASB’s Small Business Advisory Committee (SBAC), the panel that provides the board feedback about small public company matters.
Finding Satisfactory Rate Tricky
The leases standard, Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), was issued by FASB in 2016 to require companies to bring on balance sheet the full magnitude of long-term lease obligations they previously reported in note disclosures.
The rules were effective January 1, 2019, for calendar year-end public companies. Private companies have until 2021 to adopt the standard, which requires a substantial amount of effort, including software updates.
A key challenge in implementing the rules is determining an incremental borrowing rate, the rate of interest that a lessee would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. Private companies have the option to use a risk free rate, but public companies do not.
“We were in the process of doing a refinance, we got term sheets with new borrowing rates on it, so we did this hold analysis on discount rate, went to our auditors and said ‘here’s our memos, and here is all our stuff and they flat out said ‘you didn’t come up with a high enough number,’” Greene said.
“And I flat out said ‘what do you think the number should be?’ and audit partner said ‘well I think it ought to be between x and y,’ which was significantly higher than what we came up with,” she said.
Some auditors are fine with a company making the distinction for determining the rate, moving the discount rate up, starting with a risk free rate and laying on credit spread, collateralization, terms, among other factors, but others are not okay with it, according to the discussions.
“I’ve had other auditors that said ‘great, but because it’s a significant estimate, get an evaluation,’” Dominick Kerr, partner in Connor Group’s global accounting standards & professional practice, said.
Board Advisers Welcome Alternatives
The FASB has said it plans to hold a roundtable next year on lease implementation challenges, which could include issues relevant to the discount rate. (See FASB to Hold Roundtable Early Next Year on Implementation Challenges of Lease Accounting Rules in the December 10, 2019, edition of Accounting & Compliance Alert.)
Panelists signalled a willingness to have the board suggest a rate based on a lease term, stating it might be simpler.
“But obviously the higher the rate is the less the value of the liabilities and the worse off the company is the less gets put on the balance sheet,” Rick Day, partner, national director of accounting at RSM US LLP, said during the meeting. “But I think if you get a reference rate that was comparable and had some type of ‘other than risk free rate’ …. would be welcomed by a lot of people.”
For in-depth analysis of the FASB’s standard for lease accounting, please see Catalyst: US GAAP — Leases , also on Checkpoint.
Additional analysis of the lease standard can be found in the Accounting and Auditing Update Service[AAUS] No. 2016-15 and SEC Accounting and Reporting Update Service[SARU] No. 2016-13 (March 2016): Special Report: Accounting for Leases—an Explanation and Analysis of Accounting Standards Update No. 2016-02.
This article originally appeared in the December 20, 2019 edition of Accounting & Compliance Alert, available on Checkpoint.
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