The 2019 EY Homebuilder CFO Roundtable - Ernst & Young · Ernst & Young LLP is a client-serving...

The 2019 EY Homebuilder CFO Roundtable

Accounting update

6 May 2019

The 2019 EY Homebuilder CFO Roundtable | 6 May 2019 | Four Seasons Hotel Las Vegas

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The 2019 EY Homebuilder CFO Roundtable | 6 May 2019 | Four Seasons Hotel Las VegasThe 2019 EY Homebuilder CFO Roundtable | 6 May 2019 | Four Seasons Hotel Las Vegas

Veronica VrosErnst & Young LLP

Accounting update

Jeff WhittonErnst & Young LLP


Agenda

ASC 606 revenue recognition implementation considerations for private companies1. Starting the implementation process2. Tax considerations3. Challenging accounting areas4. EY tools and resourcesHow the new leases standard affects real estate entities


ASC 606 revenue recognition implementation considerations for private companies


Starting the implementation process


Starting the implementation process Lessons learned from implementation experience

► Complying with the new requirements often requires more effort than originally expected: ► Effort can still be substantial even if no material effect from adoption► May be difficult to manage ASC 606 adoption with regular responsibilities► There are risks (e.g., contract initiation, disclosures, estimates) to consider and address, even if no

material effect from adoption► Establishing a cross-functional team and determining training needs is a good place to start

► Involve others outside of accounting (e.g., sales, legal, operations, tax, IT) ► Understanding the new disclosures is important because significantly more recurring

disclosures are required than under current GAAP► Coordinating with auditors leads to a more efficient audit approach

Regardless of expected changes, private companies need to start the implementation process early


Starting the implementation processKey questions to consider

► Questions to consider when getting started:► How will the new standard affect the timing and measurement of the company’s revenue

recognition?► What are the new disclosure requirements?► How will the company’s processes be affected?► How long is the implementation going to take?

► From our implementation experience, the standard is too complex to take a high-level approach.

► Most entities have too many contracts with customers to analyze each contract individually.


Starting the implementation processRevenue recognition effect on select sectors

Less impact Considerable impact

Oil and gas/mining

Pharmaceuticals and biotechnology

Media andentertainment

Professionalservice providers

Telecommunications Technology

Automotive Health

Utilities

Construction and

engineering

Retail

AirlinesConsumer products

Banking and insurance

Real estate

Broker-dealers

Hospitality


Tax considerations


Book and tax differences in revenue Comparison of core principles

Core principle: recognize income at the earlier of when all events have occurred to earn the revenue orwhen the company is entitled to the revenue

Core principle: recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services

Book

TaxConfirm the amount of

income that can be determined with

reasonable accuracy

Determine when the company has a fixed right to the income –either when earned,

due or received

Consider special rules that change

the timing of income recognition

Step 1 Step 2 Step 3 Step 4 Step 5

Identify the contract(s) with a customer

Identify the separate performance

obligations in the contract(s)

Determine the transaction price

Allocate transaction price to the separate

performance obligations in

the contract(s)

Recognize revenue when or as entity

satisfies a performance

obligation

Identify income streams and underlying contracts


Challenging accounting areas


Challenging accounting areasTop 10 based on our implementation experience

Contract duration ► Contract provisions (e.g., termination provisions) and their effect on contract duration

Identifying performance obligations

► Determining if identified promises of goods and services should be combined into a single performance obligation

Principal vs. agent ► Determining nature of the company’s promise by identifying the specified

good or service (i.e., unit of account) and assessing if the company controls the specified good or service prior to transfer to customer

Customer options ► Distinguishing between a contract that includes customer options to

purchase additional goods and services and one that includes variable consideration based on variable quantity (e.g., usage-based fee)

Variable consideration ► Constraining the estimate of variable consideration (i.e., not defaulting to constraining to zero)


Challenging accounting areasTop 10 based on our implementation experience (cont.)

Variable consideration allocation exception

► Determining whether a company meets the criteria to apply the variable consideration allocation exception (e.g., whether the terms of a variable payment relate specifically to the company’s efforts to satisfy a performance obligation)

Residual method ► Determining whether the historical selling price is highly variable

Satisfied over time vs. point in time

► Determining whether control of goods and services is transferred over time or at a point in time

Contract costs — obtain ► Determining whether contract acquisition costs are incremental and if the company expects to recover

Contract costs — fulfill ► Determining whether costs generate or enhance resources of the

company that will be used in satisfying performance obligations in the future (i.e., second fulfillment criterion)


EY tools and resources


EY tools and resources

► Scoping revenue streams ► Revenue stream scoping questionnaire

► Contract reviews► Contract analysis enabler

► Accounting guidance, examples and FAQs► Private Company Reporting Update: “How the new revenue standard will affect private companies”► EY Financial Reporting Development Publication: “Revenue from Contracts with Customers”

► See Appendix E for example disclosure checklist for nonpublic entities► Technical Line: “Common challenges in implementing the new revenue recognition standard”► Technical Line: “How the new revenue standard may affect a company’s income tax accounting”► EY industry publications


How the new leases standard affects real estate entities


New leases standardOverview

► The new leases standard from the Financial Accounting Standards Board (FASB) requires lessees to recognize assets and liabilities for most leases (including operating leases) but recognize expenses in a manner similar to today’s accounting.

► For lessors, the new guidance modifies the lease classification criteria and leverages certain guidance in the new revenue recognition standard.

► The new leases guidance eliminates today’s real estate-specific provisions, changes sale and leaseback accounting and eliminates leveraged lease accounting prospectively.

► The effect on financial statements, business processes and internal controls will likely be significant for some entities.

► Effective date:► Public business entities (PBEs) and certain not-for-profit entities and employee benefit plans —

annual periods beginning after 15 December 2018, and interim periods within those years► All other entities — annual periods beginning after 15 December 2019, and interim periods the

following year► Early adoption permitted for all entities


New leases standardScope and scope exceptions

► Leases of property, plant and equipment

The guidance applies to:

► Leases of inventory, intangible assets, assets under construction and biological assets, including timber

► Leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources:► Leases of equipment used to explore for natural resources are not part of this scope exception

(i.e., they are in the scope of Accounting Standards Codification (ASC) 842) ► Arrangements in the scope of ASC 853, Service Concession Arrangements

The guidance does not apply to:

A lease is a contract, or part of a contract, that 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.


New leases standardDetermining whether an arrangement contains a lease

Yes

Customer

Yes No

Yes

Neither; how and for what purpose the asset will be used are predetermined

Yes

Supplier

No

No

No

No

Is there an identified asset?

Does the customer or supplier have the right to direct how and for what purpose the identified asset is used throughout the period of use?

Does the customer have the right to obtain substantially all of the economic benefits from the use of the asset

throughout the period of use?

The contract contains a lease The contract does not contain a lease

Does the customer have the right to operate the asset throughout the period of use without the supplier having the right to change those operating instructions?

Did the customer design the asset (or specific aspects of the asset) in a way that predetermines how and for what purpose

the asset will be used throughout the period of use?


New leases standardIdentifying and separating lease and non-lease components

► Many contracts contain a lease coupled with an agreement to purchase or sell other goods or services (non-lease components).► Non-lease components (e.g., maintenance activities, including common area maintenance) are

identified and accounted for separately from the lease component in accordance with other US GAAP.

► Some contracts contain items that do not relate to the transfer of goods or services by the lessor to the lessee (e.g., fees or other administrative costs that a lessor charges a lessee, payments for insurance that protects the lessor’s asset, taxes related to the lessor’s asset). ► These items should not be considered separate components. ► Lessees and lessors do not allocate consideration in the contract to these items.


New leases standardIdentifying and separating lease and non-lease components (cont.)

► Lessees can make an accounting policy election (by class of underlying asset) to account for each separate lease component of a contract and its associated non-lease components as a single lease component.

► The FASB added an optional practical expedient that allows lessors to elect (by class of underlying asset) to not separate lease and related non-lease components if the non-lease components otherwise would be accounted for in accordance with the new revenue standard and both of the following criteria are met:► The timing and pattern of transfer of the lease component and the associated non-lease

component(s) are the same.► The lease component would be classified as an operating lease if it were accounted for separately.

► If both of the criteria are met and a lessor elects to use the practical expedient, the lessor is required to account for the combined component as a single performance obligation in accordance with ASC 606 if the non-lease component is the predominant component. ► If the non-lease component is not the predominant component, the lessor accounts for the

combined component as an operating lease.


New leases standardLease term and purchase options

Overview of the new leases standard

► The FASB said that “reasonably certain” has the same meaning as “reasonably assured” in ASC 840.► Reasonably certain is generally interpreted as a high threshold.

► Purchase options should be assessed in the same way as options to extend the lease term or terminate the lease.

Leas

e te

rmAny noncancelable periods

Periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option

Periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option

Periods covered by an option to extend (or not terminate) the lease in which the exercise of the option is controlled by the lessor


New leases standardLease payments

► Lease payments should be consistent with the lease term.


Lease paymentsFixed (including

in-substance fixed) payments,

less any lease incentives paid

or payable to the lessee

Variable payments

based on an index or rate

Exercise price of a purchase

option*

Payments for penalties for

terminating the lease**

* Include only if reasonably certain of exercise** Include only if the lease term reflects the lessee exercising an option to terminate the lease

► Lease payments also include fees paid by the lessee to the owners of a special-purpose entity for structuring a transaction.► However, such fees are excluded from the fair value of the underlying asset for

purposes of the leases classification test.

Amounts it is probable that the lessee will

owe under residual value

guarantees (lessees only)


New leases standardDiscount rates

► The discount rate for the lease is the “rate implicit in the lease.”► When the rate implicit in the lease cannot be readily determined, lessees use their incremental

borrowing rate (i.e., the rate of interest that the 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).

► For purposes of determining a lessee’s incremental borrowing rate, a collateralized borrowing should also assume the lender can seek recourse through other assets of the lessee borrower. ► A lessee should start with the general credit of the company and then adjust the rate to reflect the impact

on collateral to the incremental borrowing rate.► However, the borrowing cannot be overcollateralized.

► In some cases, this rate may be the parent’s incremental borrowing rate. ► Lessees that are not PBEs are permitted to make an accounting policy election (for all leases) to use

a risk-free rate determined using a period comparable with the lease term for initial and subsequent measurement of lease liabilities.

► This policy election must be disclosed in the notes to the financial statements.


New leases standardInitial direct costs (IDCs)

► Only incremental costs qualify as IDCs.► Incremental costs are those that would not have been incurred if the lease had not been obtained

(e.g., commissions, payments made to an existing tenant to incentivize that tenant to terminate its lease).

* For purposes of performing the sales-type lease classification test only, a lessor assumes that no IDCs will be deferred (i.e., IDCs are excluded from the calculation of the rate implicit in the lease) if, at the commencement date, the fair value of the underlying asset is different from its carrying amount.

Lease classification Accounting for capitalized IDCs

LesseesOperating lease Include IDCs in the initial and subsequent measurement of the

right-of-use (ROU) assetFinance lease

Lessors*

Sales-type lease if the fair value of the underlying asset is different from its carrying amount at lease commencement Expense IDCs at lease commencement

Sales-type lease if the fair value equals the carrying value of the underlying asset at lease commencement Include IDCs in the initial and subsequent measurement of the net

investment in the leaseDirect financing lease

Operating lease Recognize IDCs as an expense over the lease term on the same basis as lease income


New leases standardCriteria for lease classification — lessees

At the commencement date, a lease is a finance lease if it meets any one of the criteria below; otherwise, the lease is an operating lease.

► 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 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 equals or exceeds 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.

* Not applicable for leases that commence at or near the end of the underlying asset’s economic life



New leases standardLessee accounting — presentation

Balance sheetROU asset Lease liability

► Present either separately or together with other assets (e.g., owned assets)

► If presented together with other assets, disclose line items that include ROU assets and their amounts

► Finance lease ROU assets must be presented separately from operating lease ROU assets

► Subject to same classification as other nonfinancial assets

► Present either separately or together with other liabilities

► If presented together with other liabilities,disclose the line items that include lease liabilities and their amounts

► Finance lease liabilities must be presented separately from operating lease liabilities

► Subject to current and noncurrent classification, similar to other financial liabilities


New leases standardLessee accounting — presentation (cont.)


Income statement

Finance leases► Present lease-related amortization and lease-related interest expense in a

manner consistent with how the entity presents depreciation or amortization of similar assets and other interest expense*

Operating leases ► Include lease expense in income from continuing operations

Statement of cash flows

Finance leases► Present principal payments within financing activities ► Present interest payments in accordance with ASC 230, Statement of Cash Flows

Operating leases► Present all payments within operating activities, except for payments that

represent costs to bring another asset to the condition and location necessary for its intended use (investing activities)

All lease types► Present lease payments for short-term leases and variable lease payments (not

included in the lease liability) within operating activities ► Make supplemental noncash disclosures

* The general expectation is variable lease costs are most appropriately presented as interest expense.


New leases standardReal estate considerations — sale and leaseback transactions

► ASC 842 also eliminates ASC 840’s real estate-specific guidance for sale and leaseback transactions involving real estate, including ASC 840’s requirement that the seller-lessee evaluate whether the sale of real estate satisfies the criteria of ASC 360-20, Real Estate Sales.

► Both the seller-lessee and the buyer-lessor are required to apply ASC 842 and certain provisions of ASC 606 to determine whether to account for a sale and leaseback transaction as a sale (seller-lessee) and purchase (buyer-lessor) of an asset.

It is likely that more sale and leaseback transactions involving real estate to be accounted for as sales and subsequent

leasebacks under the new standard than under ASC 840’s guidance.


New leases standardReal estate considerations — sale and leaseback transactions (cont.)

Is the leaseback classified as a sales-type lease by the buyer-lessor or a finance lease by the seller-lessee?

Yes

No

Is the transaction a sale under ASC 606* (i.e., does it transfer control of the asset to the buyer-lessor)?

* Excluding the evaluation of the repurchase option under ASC 606, as the repurchase option is subject to the evaluation under ASC 842 (see below)

Account for as a sale and leaseback transaction by both

the lessee and lessor

No

Yes

Does the transaction include an option for the seller-lessee to repurchase the asset?

Does the repurchase option meet both of the following conditions?► The exercise price of the option is the fair value of the underlying asset at the time the option is exercised.► Alternative assets that are substantially the same as the transferred asset are readily available in the

marketplace.

Yes

Yes

No

Account for as a financing transaction (i.e., a failed sale) by both the lessee and lessor

No


New leases standardReal estate considerations — sale and leaseback transactions (cont.)

Seller-lessee Buyer-lessorSale and leaseback transaction accounting

► Accounting for the sale:► Recognize the transaction price for the sale in accordance with the

guidance on determining the transaction price in ASC 606 at the point in time that the buyer-lessor obtains control of the asset

► Derecognize the carrying amount of the underlying asset► Recognize any gain or loss, adjusted for off-market terms,

immediately

► Accounting for the leaseback:► Account for it in the same manner as any other lease, adjusted for

off-market terms

► Additional disclosures are required

► Accounting for the purchase:► Account for the asset in accordance with ASC 360

► Accounting for the leaseback:► Account for it in the same manner as any other

lease, adjusted for off-market terms

Financing transaction (i.e., failed sale) accounting ► Keep the asset on the balance sheet ► Account for amounts received as a financial liability

► Do not recognize the transferred asset► Account for amounts paid as a receivable


New leases standardDisclosure

► Disclosure objective: to enable financial statement users to assess the amount, timing and uncertainty of cash flows arising from leases

► New disclosures for lessees and lessors include:► Significant assumptions and judgments made► Maturity analyses of lease liabilities (for lessees) or lease receivables (for lessors), separately by

lease type, as of the reporting date, including a reconciliation of undiscounted cash flows to the lease liabilities or receivables

► New disclosures for lessees include:► Separate quantitative disclosure of lease cost, by type (e.g., finance lease, operating lease, short-

term lease)► Weighted-average remaining lease term, separately by lease type ► Weighted-average discount rate, separately by lease type

► New disclosures for lessors include:► Information about management of risks related to residual values of leased assets► For sales-type and direct financing leases, explanations of significant changes in balance of

unguaranteed residual assets► Table of lease income recognized in each annual and interim reporting period


► The following practical expedients can be elected by an entity separately or in any combination:► An entity can elect to apply a package of practical expedients that allows it not to reassess:

► An entity can make an election for all existing leases to use hindsight when determining the lease term (i.e., evaluating a lessee’s option to renew or terminate the lease or to purchase the underlying asset) and assessing impairment of ROU assets (lessees only).

► An entity can make an election to continue applying its current accounting policy for all land easements that exist or expire before ASC 842’s effective date.

► An entity is required to disclose which of the practical expedients it elected to apply.

New leases standardPractical expedients

Must be elected as a package and applied to all expired and existing leases

Lease classification Whether IDCs qualify for capitalization

Whether contracts are or contain leases


Questions?

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