The new leasing standards: Is your health care organization ready?
From embedded leases to time and resources, there’s much to consider
INSIGHT ARTICLE |
Accounting for leases has been completely overhauled with the issuance of new lease accounting requirements applicable to U.S. generally accepted accounting principles: Accounting Standards Codification—Topic 842 (ASC 842), International Financial Reporting Standards—Leases 16 (IFRS 16) and the Government Accounting Standards Board—Statement 87 (GASB 87). The new leasing standards require lessees to record most leases on their balance sheets, replacing the historical accounting model where most leases were accounted for as off-balance sheet operating leases. The new leasing standards are conceptually fairly straightforward, requiring lessees to record assets and liabilities based on the present value of lease payments; however, practice has proven that implementing the standards can be exceptionally challenging both from an operational and a technical accounting perspective. The new leasing standards are effective for the fiscal years beginning after Dec. 15, 2018, for public entities and one year later for nonpublic and governmental entities.
The implementation of the new standards requires involvement throughout an organization―not just within finance. The fundamental changes in accounting for leases are likely to have significant impacts on real estate, treasury, procurement and information technology (IT). Due to the fundamental change from historical accounting standards and significant level of judgments and estimates required, it is critical that organizations have a comprehensive implementation strategy and approach.
Key leasing standards considerations for health care organizations
While the leasing standards affect entities of all industries, health care organizations have their own unique challenges implementing the new leasing standards, including:
- Lease identification
Most health care entities have a significant number of leases related to both real estate and equipment. While some organizations track and maintain leases centrally, many have a decentralized process where leases are entered into independently by different components of the organization. In these cases, identifying and compiling the increased volume of lease agreements may require unanticipated additional effort.
- Embedded leases
Even if an entity has historically identified all of its leases and has compiled the agreements, there can be other agreements that may be deemed to contain an “embedded lease.” An embedded lease is a lease that meets the accounting definition of a lease even though the agreement is not legally structured or even intended to involve a lease. For example, a service or supply agreement that involves the use of an asset may be deemed to provide the customer with a lease of the asset. If the agreement is determined to contain a lease, the lease will need to be accounted for per the requirements of the new leasing standards.
Within the health care industry it is common to have contracts to purchase various types of disposable and consumable products used in connection with treating patients. Often vendors will provide hospitals “free” medical equipment that is used with the consumable products. In these situations, the hospital often only pays for the consumables and does not make any payments for the equipment. In this fact pattern, the hospital would often have an embedded lease of the equipment. Even though no payments are explicitly related to the equipment, the hospital would, at a minimum, be required to allocate a portion of the consumable payments to the embedded equipment lease.
The process of identifying embedded leases is complicated, requires judgement, and usually involves significant time and effort but, after an embedded lease has been identified, there can still be more effort required to correctly apply the rules necessary to account for the lease. Failing to properly identify and account for embedded leases can have material impact and result in incorrect financial statements.
Accounting for leases generally requires at least 30 data inputs per lease and can require 100+ inputs (depending on how much information an entity decides to maintain). Historically, this data was not usually maintained and must now be abstracted from individual leases. Even if this data had been gathered for lease administration purposes, it often must be augmented and updated to meet the requirements of the new lease standards.
Lease agreements come in all shapes and sizes and are structured in uncountable ways. Abstracting data from the agreements is time consuming and often complex, given that accounting definitions for certain items do not always correlate to how terms are defined in an agreement.
Accounting for leases under the new lease standards requires tremendous amounts of data used to perform calculations necessary to create journal entries over the life of every lease. Additionally, lease data and calculations need to be reassessed and performed upon the occurrence of various events. Managing the data and calculations often becomes unwieldy without assistance from an accounting software solution. Attempting to maintain and account for leases without a software solution not only increases the risk of errors in lease calculations, but also significantly increases both the time accounting personnel will need to devote to lease accounting activities as well as the time and resources necessary to audit leases.
- GASB 87
While each of the new lease accounting standards requires lessees to record most leases on the balance sheet, the governmental accounting standard contains various nuances that can make it significantly different from both ASC 842 and IFRS 16 and potentially more complex for organizations that follow governmental accounting standards. First, GASB 87 includes different requirements for financial statements prepared using the economic resources measurement focus versus the current financial resources measurement focus. Also, the GASB 87 lessor accounting model is drastically different from the ASC 842 and IFRS 16 models, requiring lessors to record a receivable and “deferred inflow of resource” for all leases. Additionally, there are numerous other areas where GASB 87 diverges from the other standards.
At this point, software vendors have not focused on GASB 87. As a result, health care entities that must comply with government accounting standards may have extra challenges identifying solutions to help with implementation and ongoing accounting needs.
- Timing and resources
Experience has shown that implementing the lease standards almost always takes more time and resources than anticipated. Time after time, organizations have underestimated the difficulty with identifying and gathering leases, abstracting lease data, interpreting technical accounting requirements and implementing technology solutions.
Additionally, it is important to note that health care entities that have issued or are conduit bond obligors for securities that are traded, listed or quoted on an exchange or an over-the-counter market, must follow public company deadlines and therefore need to implement the standard for their 2020 beginning fiscal years. For example, a conduit bond issuer with a Sept. 30 year-end must implement the standard as of Oct. 1, 2019. Any organizations in this situation should be well into their implementation process.
The items above are not all-inclusive of the challenges that may arise with implementing the new lease standards. Implementing the new lease standards and accounting for leases under the new standards is challenging, time-consuming and resource-intensive. Experience has proven that implementation is almost always harder than expected. It is important to begin early, allocate adequate resources and not to underestimate the challenges.
For additional insights, note the following:
· Lease accounting update for health care organizations (recorded webcast)