Written By: Chris Garland, CHAE
The upcoming revision to lease accounting standards was one of the topics discussed by the HFTP Hotel Advisory Council in their February 2018 meeting. The surprising conclusion from the council: The hotel industry in general is not prepared for the changes, and there is no viable off-the-shelf software that any of the members were aware of that would assist with the accounting for the new standard.
Accounting Standards: Real World Examples
With the changes in accounting standards, many organizations are looking for further guidance and examples. HFTP is currently collecting example scenarios to examine the treatment under the new lease accounting and revenue recognition standards set by the IASB and the FASB.
Background
In a 2005 report issued by the Securities and Exchange Commission (SEC), it was determined that U.S. issuers of securities have approximately $1.25 trillion in non-cancelable future cash obligations committed under operating leases that are not recognized on issuer balance sheets. To solve for that and reflect the true obligations of the business, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have worked jointly on a new standard for lease accounting. The new standards released are FASB ASU 2016-2 (Topic 842) Leases and IFRS 16 Leases.
While the standard addresses both finance leases (capital leases) and operating leases, we will focus on operating leases, as that will have the greatest impact on day-to-day operations in the hospitality industry.
The changes are effective for the following fiscal years: beginning after December 15, 2018 for public companies and December 15, 2019 for all other entities.
Overview
Historically, the future payment obligations of operating leases were never recorded on the balance sheet, and therefore readers of the statements were not fully informed of the true obligations of the entity. Under the new rules, the entity will recognize the present value of future lease payments as a right of use asset and a lease liability. The right of use and lease liability will be amortized over the term of the lease based on the present value of the remaining lease payments at the end of each period. Rent expense will continue to be recorded on a straight-line basis over the term of the lease. Any difference between cash paid and the straight-line rent expense will be recorded as an adjustment to the right of use asset.
There is a divergence between the International Financial Reporting Standards (IFRS) guidance and the FASB treatment — whereby IFRS treats operating leases with values greater than $5,000 as if they were financing leases, while the FASB treatment considers operating leases as being within operating activities (i.e. not separately recognizing interest from amortization).
Requirements of the New Standard
If a lease term is 12 months or less, the lessee may elect, by class of underlying asset, not to recognize an ROU asset or lease liability. If this election is made, lease expense will be recognized generally on a straight-line basis over the term of the lease.
For all other leases, at the inception of the lease, the lessee must classify the lease as either a financing or operating lease. Operating leases are those where the lessee does not effectively obtain control of the underlying asset. Control of the underlying asset resulting in a financing lease is achieved if any of the following five conditions are met:
- The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
- The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise.
- The lease term is for the major part of the remaining economic life of the underlying asset.
- The sum of the present value of the lease payments and the present value of any residual value guaranteed by the lessee amounts to substantially all of the fair value of the underlying asset.
- The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.
When the lessee enters into an operating lease that is greater than 12 months in length, it must determine the present value of the future lease payments and record the right of use asset and the lease liability on the balance sheet.
The right of use asset will be initially recorded at the present value of future lease payments discounted using the rate implicit in the lease, adjusted for any lease payments made prior to commencement date and initial direct costs incurred. Throughout the lease term, the right of use asset is measured at the present value of remaining lease payments adjusted for cumulative prepaid or accrued rent. There will be no right of use asset on the books at the end of the lease term.
Rent expense is recorded on a straight-line basis over the term of the lease. Any difference between the cash paid and the straight-line rent expense in a period is booked as an adjustment to the right of use asset.
The lease liability will be initially recorded at the present value of future lease payments, discounted using the rate implicit in the lease. After lease commencement, the lease liability is re-measured each period at the present value of remaining lease payments using the discount rate determined at lease commencement.
USALI 11th Revised Edition Treatment
The 11th revised edition of the Uniform System of Accounts for the Lodging Industry (USALI) complies with the current generally accepted accounting principles (GAAP) treatment of operating leases, and will need to be updated through either a clarification draft or the issuance of the 12th edition to reflect these changes in 2019.
Implementation
Even though the standards do not take effect until December 2018, leases which exist prior to the effective date will need to go on the balance sheet when your company is required to make the change. It is therefore important to understand each of your lease obligations as soon as possible and plan accordingly for the implementation.
Examples Related to Hospitality
The following simple example of an operating lease for a photocopier is intended to provide the reader with an indication of the set up and recording of a common operating lease both at inception and on a monthly basis.
Sample Operating Lease – Treatment for Lessee
The actual excel spreadsheet is also displayed below as reference for the formulas.
Sources: FASB ASU 2016-2 Leases (Topic 842); BDO FASB Flash Report March 2016; PWC In brief February 25, 2016; Uniform System of Accounts for the Lodging Industry 11th revised edition.
Send Us Your Example Scenarios or Questions
With the changes in accounting standards, many organizations are looking for further guidance and examples. HFTP is currently collecting example scenarios to examine the treatment under the new lease accounting and revenue recognition standards set by the IASB and the FASB.
Chris Garland, CHAE (chris.garland@missionhospitalitysolutions.com) is principal consultant at Mission Hospitality Solutions and chair of the HFTP Hospitality Finance Advisory Council.
