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Newsletter – May 2020

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Subchapter V of the Bankruptcy Code and How This Can Help Small Businesses

The unprecedented crisis brought on by the coronavirus has hit every facet of the economy. Companies that were operating profitably and with robust growth expectations have been decimated by the impact on the health of employees and customers, of stay at home orders and disruptions to supply chains. Federal and state plans to mitigate the impact continue to roll out, but it is clear that the economy will experience devastation not seen since the Great Depression.

In this time of uncertainty, companies must plan for every conceivable outcome. Small companies in particular are especially vulnerable and must assess all tools at their disposal in order to survive.

The purpose of this newsletter is to highlight a new provision of the Bankruptcy Code which can be a lifeline to small businesses. We intend to provide you with an overview of the features of the newly enacted Subchapter V of the Bankruptcy Code so you can understand this alternative as a means to survive the current crisis. The information presented below is for informational purposes only and should not be considered legal advice or opinion, which should only be sought from an attorney.

Subchapter V is part of the federal Bankruptcy Code that came about from a new law called the Small Business Reorganization Act of 2019 on February 19, 2020. Subchapter V is aimed at small business corporate and individual debtors, and it is intended at reducing the complexities of Chapter 11 by increasing efficiency, lowering costs and easing the plan confirmation process.

Initially, Subchapter V was limited to a person or entity with total debt of less than $2,725,625. The CARES Act raised this amount to $7.5 million; this higher amount will only remain in effect until one year after the effective date of the CARES Act, i.e. March 27, 2021. The one exclusion to Subchapter V is single asset real estate entities.

The advantage of a Subchapter V filing over a Chapter 11 filing includes the following:

There are no fees, apart from an initial filing fee. Also, administrative expenses may be paid over the life of the plan (as opposed to the date of the plan confirmation as with Chapter 11 filings).
Filing requirements are the business’ most recent balance sheet, statement of operations, statement of cash flow and tax returns, or a sworn statement that such documents do not exist.
Subchapter V has no creditor committee, unless the court orders otherwise.
The petitioner will submit the plan to the court and, if it meets certain requirements, it will be accepted by the Court.

Under a typical Subchapter V filing, the chronology of events is as follows:
A status conference will be held in bankruptcy court within 60 days of filing;
The debtor must file a report detailing efforts to reach a consensual plan of reorganization no later than 14 days prior to this conference, and;
The plan must be submitted for approval within 90 days. Extensions may be granted where there are circumstances for which the debtor cannot be held accountable.

The plan will generally be confirmed as long as all disposable income for the ensuing 3-5 years will be used to repay creditors.

If creditors can’t agree on the petitioner’s proposed plan, the Bankruptcy Court Judge may be asked to order the plan approved (a “cram down”). The success of the proposed plan would need to be demonstrated to be more attractive to unsecured creditors than a conversion to a Chapter 7 liquidation plan, which is usually very easy to be made.

A small business owner may continue to operate post filing as a debtor-in-possession and must continue to file the schedules and statements required of all debtors under the applicable section of the Bankruptcy Code. However, the court can strip a small business debtor of its debtor-in-possession powers for cause such as fraud, dishonesty, incompetence or gross mismanagement, either before or after the bankruptcy case or for failure to perform the obligations specified under a confirmed plan. In such an event, a Small Business Trustee would take over the operation of the business.

In summary, the advantages of Subchapter V over a Chapter 11 filing are costs, ease of filing requirements, ability of the owner to prepare the reorganization plan without having the involvement of a creditor committee and relative ease of confirmation by the Court as long as certain hurdles are met.

For business owners who are undergoing challenges, we hope that your firm will be able to successfully withstand the current crisis and be able to return to normalcy in the near future, and that you will not need to consider Subchapter V. However, we encourage you to consider this alternative if it can result in your firm’s survival. CFO Consulting Partners can assist you in seeking legal advice and assistance from our broad network of contacts in the legal field.

Finally, we wish the best to you and your loved ones for safety and continued good health.

The content of this newsletter is meant for general information purposes and is not to be considered legal advice or opinion. As with any bankruptcy or restructuring filing, you need to consult with an attorney to cover your own unique situation and circumstances.

By Mark Sloan, Director, CFO Consulting Partners, msloan@cfoconsultingpartners.com
David DeMuth, Sr. Managing Director, CFO Consulting Partners, ddemuth@cfoconsultingpartners.com

Survive, Stabilize and Thrive – CRE Coronavirus Impact

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Over the last week we have seen unprecedented actions to attempt to minimize the impact of COVID-19 on us and give our health care system the ability to support us during this crisis. As a result, it has affected our normal day to day activities, resulted in the closure of all non-essential businesses and has presented the businesses that do remain open with many challenges. It has morphed into a longer lasting and more intense shutdown of activities throughout the country. As of this writing, there is still a lot of uncertainty that all of us must undergo. For our businesses, we must evaluate how we survive, then stabilize and then thrive once we get through these unprecedented times.

Our Real Estate Group, David DeMuth, John Kovacs, Mark Sloan and Mario Tamasi have extensive experience in the CRE industry each in varying degree. Please feel free to visit our website at www.cfoconsultingpartners.com to see our background and experiences.

Real estate owners have had to endure interruptions in their cashflow as a result of various prior events and as everyone knows the Coronavirus event will be the same. With all the information that has come out about the impact, a leadership roadmap should have the following themes:

1. Communication to employees, tenants, BOD, and stakeholders
2. Business operations continuity to Survive and Stabilize
3. Financial planning adjustments to operations and processes
At this point, many tenants are looking to survive and stabilize. The strength of a property’s cashflow is its current tenants. If they are having issues, then the real estate owners will feel the pressure on cashflow and making mortgage payments and operating expenses.
The following are various specific actions to consider:
a) Review current lines of credit capacity. If needed, begin discussions with lenders to increase or provide new line of credit.
b) Review collateral which may be needed for additional sources of financing.
c) Review current working capital and financial liquidity.
d) Setup best practices for tenant request for rent relief (i.e., require current financial information, forecasts, etc.).
e) Consider requests from tenants for rent relief and model appropriately.
f) Maintain transparency with lenders on lease restructures, temporary suspension or modification of debt payments, etc.
g) Refer tenants to the federal and state websites which may assist them during this time.
h) Review federal and state programs which may assist you as Landlord.
i) Review insurance policies for coverage as a result of COVID-19.
j) Increase monitoring of accounts receivable and cash receipts.
k) Implement weekly cashflow analysis for impacted properties.
l) Take realistic steps to increase cashflow and reduce expenses.
m) Review additional costs in connection with maintaining Common Areas of properties under federal guidelines concerning Coronavirus.
n) Review Proptech for reducing property costs such as energy costs, etc.
o) Refinance existing loans with lower rate, long term loans.
p) With any changes to cashflow, develop revised cashflow budgets and forecasts for the overall organization.

q) For some property types, consider the repositioning of idle properties, and consider use as medical facilities to assist authorities in providing medical services and testing.

Most of you as CRE owners are aware of the above and these are reminders during these unprecedented times. Our tenants, vendors, and the public need to survive, stabilize and then we will all thrive as we are all in this together.

If CFO Consulting Partners can help your organization with additional support and skill sets of experienced real estate professionals, please do not hesitate to contact us.

We hope your families, employees, and colleagues remain safe and healthy during these unprecedented times.

Mark Sloan, Director — msloan@cfoconsultingpartners.com
Mario Tamasi, Director – mtamasi@cfoconsultingpartners.com

Newsletter – June 2019

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Qualified Opportunity Zones – an Executive Summary

Mark Sloan, Director, CFO Consulting Partners

There has been much discussion regarding Qualified Opportunity Zones (“QOZ”), the tax benefits of investing in a QOZ and how it should fit into a strategy of minimizing taxes on long term capital gains. This newsletter will provide an overview as to the rules governing QOZ and some practical considerations regarding investing in QOZ.

BACKGROUND:

As a result of the Tax Cut and Jobs Act (“TCJA”) passed in late 2017, a taxpayer may elect to recognize certain tax deferrals and exclusions on the gain realized from the sale or exchange of property to an unrelated party if the gain is reinvested in a qualified opportunity zone fund within 180 days from the date of the sale or exchange and the gain remains invested for a defined period of time.

Opportunity zones are eligible low-income census tracts that had either poverty rates of at least 20 percent or median family incomes no greater than 80 percent of their surrounding area’s, according to the U.S. Census Bureau’s 2011-2015 American Community Survey. Such tracts have been nominated by governors and certified by the U.S. Department of Treasury for designation as an Opportunity Zone. There are over 8,700 such tracts located throughout the United States.

A qualified opportunity fund (“QOF”) is the vehicle to which gains must be invested in order to qualify for the tax benefits of the program. In order to achieve the tax benefits, the taxpayer must invest in a QOF and not directly into qualified opportunity zone property. A QOF is a corporation or partnership organized with the specific purpose of investing in opportunity zone assets. The entity must invest at least 90% of its assets in qualified opportunity zone property.

Qualified opportunity zone property can be in the form of direct ownership of business property, or into opportunity zone portfolio companies through either stock ownership or partnership interest. Certain businesses are precluded for consideration as property to be held by opportunity zone portfolio companies and these include golf courses, country clubs, massage parlors, tanning salons, hot tub facilities, racetracks, casinos or any other gambling establishment and liquor stores. These limitations do not apply when a QOF is investing into the Qualified Opportunity Zone directly.

Upon the investment of qualified gains, the basis in the capital gains will be zero. The gain will then be recognized into income on the earliest of the disposition of the opportunity zone property or December 31, 2026. If the QOF is held five years, then the taxpayer’s basis is increased by 10% of the original gain and then it is increased another 5% if held for another two years. If the QOF is held at least ten years, then all gains attributable to the appreciation on the original gain will be excluded from income.

BENEFITS:
There are numerous tax benefits attributable to the timely investment of capital gains into a QOF.

  • Deferral of tax on invested capital gains until December 31, 2026, at the latest;
  • Permanent exclusion of tax on capital gains of up to 15% if held for seven years, and;
  • Permanent exclusion of tax on any subsequent appreciation on the invested capital gains if held for more than ten years.

OTHER CONSIDERATIONS:

There are other advantages to investing in a QOF that make it a more flexible option to Section 1031 as a means to shelter capital gains:

  • As opposed to Section 1031, which requires the investment of the full proceeds in order to qualify for temporary tax deferral on gains, only the gain portion of the proceeds needs to be invested, freeing up cash at the time of the original sale of capital assets.
  • Investment in a QOF can provide permanent exclusion of tax on a portion of capital gains; Section 1031 transactions will only provide for deferral of tax on capital gains.
  • As opposed to Section 1031, which requires the investment of proceeds into like kind assets, the only requirement for a QOF is that the gains are invested into opportunity zone assets. For example, if a work of art is sold at a gain, then the gain can be invested in a different class of asset such as real estate.
  • It should be noted that as a result of the TCJA, the use of Section 1031 is now limited to real estate assets and no longer other types of capital assets.

While there are significant benefits to investing in opportunity zone funds, there are certain caveats that need to be considered:

  • If the investment has not been disposed of sooner, the invested gain will be recognized in income at December 31, 2026. This means that the taxpayer will need to provide liquidity for this event while the gain is still locked up in the investment.
  • To achieve the 15% permanent exclusion on the original gain, there must be a rollover of the gain no later than December 31, 2019 in order to achieve the 7 year holding period for this exclusion.
  • To maximize the tax benefits attributable to this program, the strategy is to lock up the invested gains for a period of ten years. This could result in a lower IRR over the life of the project.
  • Although the census data used to designate tracts as opportunity zones is dated and there may be some areas that have gone through improvement, there can still be a higher risk attributable to investing in areas that are opportunity zones.
  • An investor may not contribute appreciated property directly into the QOF. Such property must be first sold (and begin the clock running for the recognition of a portion of the gain) and the amount attributable to the gain invested into the fund.
  • The regulations impose limitations on the amount of cash and intangible assets that can be held at any time by an opportunity zone fund. This limitation can be mitigated through a structure where the QOF invests into an opportunity zone portfolio company (either through stock ownership or partnership interest). Under this structure, the portfolio company can hold intangible assets that are used in an active trade or business and cash in an amount for reasonable working capital needs.
  • The investment in opportunity zone funds should be evaluated on the overall economics of the fund and its strategy, and there should not be disproportional weight given to the tax deferral/exclusion feature of the program as the basis for investing in the opportunity zone.

This newsletter is meant as a broad overview on Qualified Opportunity Zones. There are many other details concerning the structure of funds, limitations on the type of assets that can be held by a QOF, determination of original use and subsequent improvements, etc. CFO Consulting Partners has been following developments in this area and we stand ready to provide you with guidance in navigating through this new and challenging area. In addition to helping you understand the details and advising you if this program can fit into your investment strategy, we also have relationships with various sponsors and service providers who can offer you opportunities with various funds that they have established. We also have relationships with law firms who can evaluate that the funds are structured in accordance with Treasury regulations.

CFO Consulting Partners is a proud sponsor of the Exit Planning Exchange (XPX). XPX is a multi-disciplinary community of professional advisors who work collaboratively to help owners build a valuable business and assist them in preparing and executing a successful transition.

CFO Consulting Partners XPX Advisors:

Oliver Brooks

Steven Crowley

David DeMuth

John Kovacs

Mark Sloan

Allan Tepper

Joseph VonEhr

Newsletter – February 2019

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Implementation of the New Lease Standards by Lessors Under the ASC 842 (Part 2)

Mark Sloan, Director, CFO Consulting Partners

In our newsletter for January 2018, we discussed the new guidelines under ASC Section 842 regarding the recognition and financial reporting of leases. In that newsletter, the focus was primarily on the lessee, as there are significant changes affecting lessees, e.g., the recognition of a right of use asset and a corresponding liability on the balance sheet, and the concept of embedded leased assets within service agreements, to name a few. In this newsletter, the focus will be on the impact of this standard on lessors. 

In addition, during the year, there were updates to ASC 842 providing clarification to the intended application of certain aspects of the standard, correct cross-reference inconsistencies, and provide entities with an additional optional transition method. This newsletter will focus on the additional optional transition method that is available for all entities. 

EFFECTIVE DATE OF IMPLEMENTATION:

ASC 842 is effective for public firms, certain not-for-profits and certain employee benefit plans in years beginning after December 15, 2018 (including interim periods) and for all other entities in years beginning after December 15, 2019 and interim periods within fiscal years beginning after December 15, 2020. Earlier application is permitted for all entities.

TYPES OF LEASES UNDER ASC 842:

Under ASC 842, there are three types of leases that a lessor will record:

  • Sales-type
  • Direct financing
  • Operating

A fourth type lease which was allowed under previous GAAP, leveraged lease, has been eliminated under the new ASC. 

A lessor will use the same lease classification criteria used by a lessee to determine the type of lease to be recorded. The five criteria are as follows: 

1)      Ownership is transferred at the end of the lease;

2)      A bargain purchase option exists;

3)      The lease term approximates the remaining economic life of the asset (assuming the lease term does not commence toward the end of the life of the asset);

4)      The present value of the lease payments and any residual value guarantees equal or exceed the fair value of the asset, and;

5)      The leased asset has no alternative use to the lessor at the end of the lease. If any of the above criteria is met, the lease will be determined to be a sales-type lease.  Assuming the collectability of the lease payments is probable, the lessor will then, on commencement date of the lease, derecognize the carrying value of the underlying asset, and recognize the following: 

a)       A net investment in the lease, comprised of:   

1)      The present value of the lease payments to be received and the guaranteed residual value (both discounted using the rate implicit in the lease), and;

2)      The unguaranteed residual asset, i.e., the present value of the amount the lessor is expected to derive from the underlying asset not guaranteed by the lessee, discounted using the rate implicit in the lease.

b)      Any selling profit or loss arising from the transaction, and;

c)       As an expense, any initial direct costs.

After the commencement date of the lease, the lessor will recognize the following:

a)       Interest income on the net investment in the lease;

b)      Variable lease payments which are not included in the initial net investment as either profit or loss in the period where the changes in facts and circumstance on which the variable lease payments are based occur, and;

c)       Impairment of the net investment if such impairment is determined to arise.

If the collection of the lease payments is not probable, then the lessor would continue to reflect the underlying asset on its books, record depreciation expense on such asset and treat the lease payments as unearned income. Such accounting will continue until the collection of the rent payments is deemed probable, the contract has been terminated or the lessor has repossessed the asset. Upon the determination that the collection of the lease payments is probable, the unearned income would be reversed, the carrying value of the asset would be charged off to operations, and the present value of the remaining lease payments, the guaranteed residual value and the present value of the unguaranteed residual value would be recorded as a net investment.

If the transaction does not meet any of the above five criteria, the lease should be evaluated for the following two conditions:

1)      The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments and/or any other third party unrelated to the lessor equals or exceeds substantially all of the fair value of the underlying asset, and;

2)      It is probable that the lessor will collect the lease payments plus any amount necessary to satisfy a residual value guarantee. 

If the lease meets both the above criteria, it shall then be classified as a direct financing lease. The main difference between a sales-type lease and a direct financing lease is the presence of a guaranteed residual value provided by a third party. Also, as opposed to a sales-type lease where initial direct costs are expensed out at the commencement date, under a direct financing lease, such initial direct costs shall be capitalized using separate discount rate and included in the measurement of the net investment in the lease. Another difference between a sales-type lease and a direct financing lease is that in a direct financing lease, the selling profit is required to be deferred at the commencement date and included in the measurement of the net investment in the lease. Such profit will be recognized into income over the terms of the lease. Any loss arising from the transaction will be immediately recognized (similar to a sales-type lease). 

If a transaction is determined not to meet the criteria of a direct financing lease, it will then be recognized as an operating lease. As such, the lease payments are recognized in income over the straight line method (unless there is another systematic and rational basis that better represents the underlying transaction), variable lease payments are recognized as income in the period in which changes in facts and circumstances giving rise to the payments occur, and initial direct costs are reflected as an expense over the lease term on the same basis as lease income. The leased asset continues to be shown on the balance sheet of the lessor, with periodic charges to reflect the depreciation of the asset. Fundamentally, the accounting for an operating lease for a lessor remains consistent with the guidance found in the previous standard (ASC 840). 

OTHER CONSIDERATIONS:

If a lease agreement is replaced by a new agreement with a new lessee, the lessor shall account for the termination of the original lease and shall account for the new lease as a separate transaction. 

Also, under ASC 842 and consistent with the treatment required of lessees, lessors are required to allocate consideration in a contract into separate lease and non-lease components. Using the guidance on variable consideration under ASC 606 Revenue Recognition, this would relate to the transfer of one or more goods or services that are not leases or an outcome from transferring one or more goods or services that are not leases. An example of a non-lease component would be payment by the lessee to the lessor for common area maintenance, utilities or cleaning services.   There is a practical expedient that a lessor can elect and that is, by class of underlying asset, not to separate non-lease components from the associated lease component and instead, to account for those components as a single component if the non-lease components would otherwise be accounted for under the new revenue guidance under ASC 606 and both the following are true:

1)      The timing an pattern of transfer of the non-lease components and lease components are the same, and;

2)      The lease component, if accounted for separately, would be accounted for as an operating lease.

If the non-lease component or components associated with the lease components are the predominant component of the combined components, then the entity is required to account for the combined component in accordance with ASC 606, Revenue Recognition. Otherwise, the entity must account for the combined component as an operating lease in accordance with ASC 842. 

There can be complex transactions involving sales and leaseback arrangements and the accounting for deferred taxes which are beyond the scope of this newsletter. This newsletter is intended to provide a very high level summary of the more pertinent areas of the new standard. 

TRANSITION METHODS:

In the financial statements in which an entity first applies the standard, the entity will apply the standard to all leases that exist at the beginning of the earliest comparative period presented. An entity shall adjust the equity at the beginning of the earliest comparative period presented and other comparative amounts disclosed for each prior period presented. 

A lessee may elect not to apply the standards to short-term leases, i.e. leases with a term less than twelve months. 

Practical expedients were provided in the initial ASC 842 standards. They must be elected as a package and applied consistently to all leases that commenced before the effective date of the standard: 

1)      An entity need not reassess whether any expired or existing contracts are or contain leases;

2)      An entity need not reassess the lease classification (i.e., operating or finance lease) for any expired or expiring leases, and;

3)      An entity need not reassess initial direct costs for any existing leases. 

Another practical expedient that is available is the entity may elect to use hindsight in determining the lease term (including purchase options) and in assessing impairment of the entity’s right-of-use asset. This practical expedient may be elected separately or in conjunction with practical expedients mentioned in the aforementioned paragraph. 

Accounting Standards Update 2018-11 provides entities (both lessees and lessors) with an additional optional transition method upon adoption. An entity may elect, in lieu of restating prior years financial statements for the implementation of ASC 842, to recognize a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption. For an entity providing comparative financial statements, the statements for the periods prior to adoption would continue to reflect the standards under ASC 840, along with the footnote requirements under ASC 840 for such periods. 

Public firms will need to disclose the effect on the pronouncement in the footnotes for 2018 financial statements, assuming they do not elect early adoption. 

This summary, along with our newsletter of January 2018, is intended to provide an overview of the new pronouncement for lease accounting. This implementation is expected to have a deep impact on most entities and with the implementation date rapidly approaching, it is imperative that firms begin to understand the standard and assess the effect this pronouncement will have on their financial statements. For public firms, they will need to begin to reflect this new standard in their first quarterly financial statements for 2019. 

CFO Consulting Partners has an extensive understanding of the new standard, and assist companies in the evaluation and implementation of this standard.

Newsletter – January 2018

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Implementations of the New Lease Standards Under the ASC 842

Mark Sloan, CPA, CFO Consulting Partners

On February 25, 2016, the FASB issued new guidelines under ASC Section 842 regarding the recognition and financial reporting of leases. The new standard will impact both lessees and lessors, with the most significant impact falling upon lessees. The standard is effective for years beginning after December 15, 2018 for public firms and December 15, 2019 for nonpublic firms.

This is one of the most comprehensive changes to accounting principles in many years, almost 250 pages long, and it will require major effort of firms to understand and implement its impact.

Due to the complexity of this pronouncement, this update will focus on the impact the new standard will have on lessees; a future update will focus on the impact on lessors.

In summary, the significant effect of this standard on lessees is as follows:

  1. Transactions which had been previously reflected as rent expense on the income statement will now require a right-of-use asset and a related lease liability being reflected on the balance sheet;
  2. Service arrangements for the use of assets over a period of years need to be evaluated and, if certain criteria is met, there needs to be a segregation of elements that are considered either lease components or non-lease components;
  3. Lease liabilities must be continually evaluated for the occurrence of significant events and revised accordingly, and;
  4. Criteria under previous guidance for determining a lease to be either an operating lease or a financing lease has been changed for the following:
    1. eliminating specific guidance regarding thresholds for determining economic life and fair value of leased assets;
    2. replacing such guidance with transaction specific judgement, and;
    3. adding a criteria that the leased asset has no alternative use to the lessor at the end of the lease term.

As a result of the new standard, it is expected that balance sheets will increase with over $1.5 trillion of additional assets and liabilities.

As a starting point, contracts for services must be reviewed, and both the lease and non-lease components must be identified and segregated. In its simplest terms, the standard states that if a contract conveys the right to control the use of identified property, plant or equipment (an identified asset) for a period of time in exchange for consideration, without significant control or substitution rights by the lessor, then a lease exists.

This will be among the most challenging aspect of the new standard. There must also be an analysis to determine whether there are multiple lease components which need to be accounted for separately and whether there are multiple non-lease components which should be accounted for under other appropriate GAAP. Also, there needs to be an ongoing evaluation of contracts to determine when an event occurs that may change the recognition or measurement of the lease, and that the entity distinguish whether there is a modification of an existing lease or the recognition of a new lease arrangement requiring separate accounting.

In addition to arrangements which clearly demonstrate a lessee/lessor relationship (such as the lease of office space), other arrangements must be carefully evaluated to determine if a lease exists. Such arrangements may include:

  • Advertising agreements
  • Service agreements
  • Transportation agreements
  • Construction agreements
  • Related party arrangements

It is important to identify lease and non-lease component of a service arrangement. The arrangement must be carefully evaluated for any asset that could be construed to be a lease in nature. One example is a data storage arrangement with a service provider. If the service contract includes the installation of a server on the location of the lessee, the lessor has no substantive substitution rights and the lessee derives most of the benefit of the asset over the lease term, then the server represents a lease component. An allocation of the rent payments need to be made between the server (the lease component) and the data storage (the non-lease component). The lease component must then be evaluated for either an operating lease or a finance lease and treated accordingly. The major difference between the two types will be that the income statement effect of the operating lease will be through rent expense while the income statement effect of the financing lease will be through interest expense and amortization expense.

Similar to previous guidance, leases meeting certain criteria will be considered a finance lease and there will need to be a right-of-use asset with a corresponding lease liability reflected on the balance sheet. The two amounts will be initially set up as the present value of the lease payments discounted at an appropriate interest rate (e.g., the lessee’s incremental borrowing rate).

A lease meeting any of the five following criteria will need to be classified as a finance lease:

  1. Ownership of the leased asset transfers at the end of the lease term;
  2. A bargain purchase option (i.e., one that is reasonably certain to be exercised) for the leased asset exists;
  3. The lease term, which does not commence near the end of the economic life of the leased asset, is primarily the remaining economic life of the leased asset;
  4. The sum of the present value of the lease payments and the residual value guarantees is equal to, or more than, substantially all of the fair value of the leased asset, and;
  5. The leased asset has no alternative use to the lessor at the end of the lease term because of its specialized nature.

What is important to bear in mind is the new pronouncement removes the 75% (for criteria #3) and 90% (for criteria #4) that former GAAP had provided as guidance and, instead, the lessee will need to take positions as to determining the remaining economic life or substantially all of the fair value of the leased asset. Also new is criteria #5 which needs to be taken into account in the determination of the character of the lease. The right-of-use asset will be amortized on a straight line basis (or any more systemic approach) over the term of the lease and the lease liability will be extinguished using the effective interest method. The income statement will reflect amortization expense for the reduction of the right-of -use asset and interest expense for the interest component of the lease payments.

If a lease arrangement is identified and considered not meeting the above criteria for a finance lease, then such operating lease will reflect, on the balance sheet, a right-of-use asset and a corresponding liability recorded at the present value of the rent payments, using an appropriate interest rate such as the lessee’s incremental borrowing rate. Both the amortization of right-of-use asset and the accreted interest on the lease liability will be reflected in rent expense on the income statement.
If an entity has both finance leases and operating leases, then the right-of-use asset and the lease liabilities must be presented separately for each type of lease.

If there are elements in the lease arrangement for step-up in rent payments, initial direct costs, payments of residual values, etc., such elements must be taken into account in calculating the right-of -use asset and corresponding liability.

Leases with terms of 12 months or less will be exempt from the standard as it relates to reflecting a balance sheet impact. Such leases will continue to be accounted for as under previous guidance, i.e., off balance sheet and footnote disclosure only.

As part of the transition process for the standard, there are practical expedients that an entity may elect, as a package and applied consistently, to all of its leases which commenced prior to the effective date of the standard:

  1. An entity need not reassess whether any expired or existing contracts are or contain leases;
  2. An entity need not reassess the lease classification (i.e., operating versus finance lease) made under previous GAAP for any expired or existing leases, and;
  3. An entity need not reassess initial direct costs for any existing leases.

If an entity foregoes these practical expedients, then it must apply the standard to all previous periods presented for which there are leases or contracts which contain lease and non-lease components.

On January 5, 2018, the FASB issued an Exposure Draft revising some of the provisions of ASC 842. The Board is requesting comments to this Exposure Draft no later than February 5, 2018.

The two issues on which the Board is seeking comments are as follows:

  1. Comparative reporting for initial adoption, and;
  2. Separating and allocating lease and non-lease components in a contract.

As it relates to comparative reporting for initial adoption, the Board has proposed recognizing a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. As it relates to separating and allocating lease and non-lease components in a contract, this proposed amendment would be applicable to lessors only. The amendment would provide lessors with a practical expedient that is currently available to lessees, which is to not separate non-lease components from related lease components for identified classes of underlying assets. This practical expedient would be available only upon meeting certain requirements, i.e., (i) the timing and pattern of revenue recognition for the non-lease component(s) and related lease components are the same, and (ii), the combined single lease component would be classified as an operating lease.

A subsequent newsletter will provide an update to the standard once the comment period has expired and the Board has finalized any revisions to ASC 842 regarding the aforementioned issues.

As can be seen from this brief summary, the new pronouncement on lease accounting will have a deep and profound effect on most entities. While the implementation date is still some time off, it would be prudent to begin to assess the effect this pronouncement will have on your financial statements. We here at CFO Consulting Partners have an extensive understanding of the new standard and stand ready to assist in evaluating and implementing this standard.

Newsletter – December 2017

By

Physician Practices: The Future is Changing

John DeLorenzo, MBA, CFO Consulting Partners LLC

The United States possibly has the most complex healthcare system in the world. The American healthcare system regulates the industry at both the federal and state level. It is paid for by private health insurance as well as from the government under its Medicare and Medicaid programs. Healthcare services are provided by the private sector; however, the government also provides services directly through the Veterans Administration. All of this, in a population with disparate levels of wealthy and poor citizens, leads to highly chaotic distribution of care and a complex payment system.
While half of all Americans receive healthcare coverage through their employers, most plans are subject to regulations both federally and at the state level. Those Americans receiving healthcare coverage through Medicare and Medicaid, subject the provider to lower reimbursements. As a result, some providers are less willing to take on Medicare and Medicaid patients, leading to a shortage of providers for that patient base. Patients that are not covered by their employer or a federally provided healthcare program are required to seek private insurance. However, because of the Patient Practice and Affordable Care Act (PPACA), patients are generally provided less options then employer plans, and those options may restrict their choices regarding providers.
Because of a more recent development, a totally different method of reimbursement, from fee for service or volume payments, to outcome based reimbursements or Value Based Care (VBC) is being encouraged by both Centers for Medicare and Medicaid (CMS) and by private insurers. Essentially, fees for services under VBC are paid based on case outcome and the payment must be shared by all providers in the continuum. VBC reimbursement was originally introduced by the CMS. Both CMS and now private insurers are moving in the direction of value based reimbursement and providing incentives to providers to participate. What is essential to succeed in the VBC method of reimbursement lie in integration of providers and the ability to aggregate data.
Even prior to the movement to VBC, the PPACA is requiring all practitioners to utilize Electronic Medical Records, (EMR) which is costly in both software acquisition as well as implementation. While a burden to small practitioners and groups, EMR will ultimately allow groups to operate, integrate and bill more efficiently.
As new requirements continue to be heaped on single physician practices and small groups, they have been dwindling as more groups consolidate to gain scale and integration. Also, there is a significant trend toward physician groups selling their practices to hospitals as hospitals are a significant cog in the VBC wheel.
Sole practitioners and practice groups need to assess their situations and determine if they are positioned to continue independently or should they align with a network of providers or sell to a larger group or hospital.
Viability in the changing healthcare delivery model for practice groups will require a significant change in how a practice operates, will require investments in information technology, possibly require upgraded staffing as well as the development of relationships with other providers in the continuum.
CFO Consulting Partners healthcare practice is here to help you. We can assist you to access your current situation and help you create and implement a plan forward. We can also assist you should you decide to align with a network or sell or consolidate with another group or hospital.

 

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