Author: C.O.R.E. Beliefs by John

New Rules for Leases

For decades now, businesses have been able to treat certain capital transactions as “off-the-books”, meaning that they didn’t have to record the debt and capitalize the asset. This method of treating leases was codified in ASC 840.   This is all about to change for leases beginning in the year 2020 for small businesses.  Beginning in 2020, (2019 for publicly traded companies) lease transactions will follow ASC 842.

The new lease rules will hit lessee’s hardest.  Lessor’s will see some new disclosure requirements but their accounting treatment will remain similar to what they do now.

The biggest change?  Beginning in 2020, you will be required to show a debt for the lease commitment and related asset for the “Right of Use” of the leased asset.  This means all that equipment you have been leasing will now show up on the balance sheet and run up the amount of debt you have on the books.

This may well have a major impact on businesses with loan covenants which restrict the amount of debt that the Company can incur.  If you are a business, such as a highway contractor, who leases equipment, you will want to start talking with your lender and bonding agent about the potential impact of this new accounting standard.

As for the technical details of the new standard, one thing that changes is in the definitions.  Property and buildings are now the only things considered operating leases.  Almost every other asset lease will be considered a financing lease.  The split is based on the “Consumption (usage and wear) of the underlying lease asset”.  If the lessee “consumes” a significant portion of the asset, it is considered a financing lease.  If it doesn’t, it is a capital lease.

An example might help.

You need warehouse space.  You find 5,000 square feet of warehouse space and lease it for $12.00/sf for a 5 year term.  At the end of the lease you will turn it back to the lessor in the same condition you originally found it.

Since the land will last indefinitely and the structure 50 or more years, you are considered to not put significant wear and use (i.e. consume) on the leased asset.  Accordingly, you enter into a capital lease.

In comparison, you are going to lease 3 trucks for your business to deliver goods to customers.  These are 60 month leases for $1,000 each truck.  You could purchase the trucks new for $70,000 each.  Since the trucks have a typical economic life of 7 years and the lease payment represents a substantial portion of the asset’s value, these would be considered financing leases.

Why does it matter?  Well, as you might infer from the name, financing leases will report financing costs – interest expense.  Capital leases will only report lease expense.  However, both do require recording the lease asset – the Right of Use (RoU) and the corresponding liability at the present value of the lease payments.

To calculate the present value, you need to know 3 things: 1)The number of periods to make the payment;  2) the payment amount; and 3) the interest or discount rate.  Guess what, 2 of the 3 are provided but the interest rate? Typically not.

The interest rate to use will either need to be stated by the lessor or you as the lessee will need to impute your rate.  So, for the truck lease above, the capitalized value with an interest rate of 4.5% is $53,000; but if the interest rate is 9.0%, then the amount capitalized is only $47,000.  And if your only source of additional capital is your credit card at 18% interest, well, your capitalized value will be much lower but your interest cost will skyrocket.

Why does all this matter?  Because there is far too much debt off balance sheet and note disclosure, especially for small business, was typically weak on the subject of the lease contingency.  Although there is some additional work, it doesn’t take a huge amount of skill to set up a PV formula in Excel.  Obviously, the hard part will be in identifying the interest rate to use and also to account for step increases and other lease costs but it is not terribly complex.

As you approach 2020, make sure your accountant is up-to-speed on the new lease rules.  You as the business owner or bookkeeper will need to provide more information to the accountant so it is set up correctly and the asset and debt recorded.  And you will want to make sure you have a conversation with your lender well in advance of that financial statement as you do not want underwriting surprised by the sudden increase of debt that shows up on your financial statements.

Have a great day.  If you would like to know more about the details of the upcoming changes to the lease rules, you should discuss with your accountant or feel free to write me anytime.  And if you are looking for a more proactive accountant, feel free to contact me anytime for a free consultation.

 

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The Possible

There are times when I think we do not spend enough time thinking about the possible.  What I mean to say is, we are almost always fixated on the probable, or most likely to happen, outcome.  This is as true in accounting and auditing as it is in life itself.

One important aspect of our role as auditor though, is to consider the possible.  For instance, theft of company assets.  When we look at how assets are controlled, from their purchase to their ultimate disposal, we are looking for possible holes in that system.  Who approves a bad debt write-off, who can set the selling price of a piece of equipment that is no longer in use; the issues which concern is are possibilities.

If we focused solely on the probable, we would potentially miss a warning sign.  Is it probable that the purchasing agent is receiving a kick-back from a vendor for steering business their way?  Maybe not.  But what controls, what business process reduces the possibility?

It is one of the things that concerns us regarding condo and HOA audits.  As the association’s independent auditor, we are first and foremost concerned with the financial statement and the fact that it is materially correct.  But when you think about what provides a materially correct financial statement, it is all the controls and safeguards of the manager – who is charged with the board with carrying out the daily activity of the association.

This is the main reason we spend so much energy on understanding how the community manager does the job.  Who has access to a checking account, who initiates the transaction, who approves it?  These points reduce or increase the risk of misuse of the association’s assets. There are far too many stories about trusting a system that really did not provide any safeguards and addressing that possibility is the responsibility of the auditor.

For instance, what if employee A of the community manager could initiate a transaction for say, yard maintenance.  Employee A contacts the maintenance company, negotiates the price and sets the contract.  Employee A then reviews their work and approves payment.  Finally Employee A can write the check and have someone else sign.

This seems harmless doesn’t it?  After all, employee A can’t sign the check so the asset is safeguarded right?  Not at all.  Employee A could have created a fact maintenance transaction, set up a fake company, approved the work and, because everything was signed off on, the check is cut.  To employee A.

Is it probably this happens in any particular association?  No.  But this scenario could result in this possible outcome.  And the auditor should know that and make appropriate comment.

Community Managers will argue that this couldn’t happen.  They are, however, arguing that it is not probable because they believe they know their employees.  The fact that it could happen though is what we are concerned with when we try to determine the risks of weak internal controls.  Boards need to be made aware that the risk exists so they can take steps, if they feel it necessary, to eliminate, or at least reduce, the risk of it happening.

As a director, make sure your auditor works to understand how the community manager is operating and how it impacts your association.  Press them on their thoughts on what risks might exist to the assets of your association.  Your auditor should have a good grasp of the fundamentals of the control system and can give you some good points to consider.  And if they can’t, it may be time to switch auditors.  C.O.R.E. is here to help you, the board, rely upon your manager.  We do this by looking at the managers controls and how they impact your association.  Feel free to contact us to schedule a conversation about how we can be of service to your association.

Have a great weekend.

 

Excellence

Topic number 3 today so far.

I am in the process of designing our proposal template.  Actually templates because we will end up with several different ones for each type of work we do.  I was originally going with only having one but doing so required far too many variables.  Take an audit proposal, as an example, we list out several things that could cause the clients costs to increase beyond what was quoted.  We decided to do that because our goal is to provide a high quality and fairly (i.e. low) priced audit.  But when there is a lack of cooperation our time commitment increases and so does the cost.  We wanted to convey this fact to the reader.

For a review engagement we don’t face those same sorts of hurdles.  So the list is not only smaller but vastly different.  It would take a lot of variable programming to make use of a single template which added and subtracted elements.  I dislike the idea of having multiple templates but we want to provide proposals now and we want them to feel right.  So we did a trade-off and I am learning to be ok with that.

Yes, I strive for excellence.  I strive for things working well and with the least amount of effort.  In my mind excellence is an attitude that says I will always try to improve.  Improve me, my relationships, my work experience.

But I am not a perfectionist.  Not by a long shot.  I believe in the concept of materiality; not only as it applies to auditing and accounting but in life in general.  Some things just are not material – they seem important but in reality have little impact on decisions.

For example – I love giving examples – lets talk accounting adjustments.  In my mind, a client’s accounting records, the trial balance they send me, is the Word.  I treat it as true and correct, to the best of the clients knowledge and ability.  Which means that it holds blemishes and inaccuracies.  It has to as it was crafted by a person.

The perfectionist accountant wants everything to “tick and tie”.  They immediate start making $2.00 adjustments to “tie-out” the depreciation schedule to the trial balance.  They go through each line item in hopes of bringing the trial balance to the “right” numbers.  And in the process cost the client thousands of dollars.

We focus on excellence.  Excellence starts with the end product in mind.  Lets say atax return.  An excellent tax return is one that can be filed and then never recalled.  What keeps it from being recalled?  Certainly not the little differences between supporting schedules and the trial balance.  Material differences cause returns to be recalled.

Sometimes materiality is an amount, sometimes it is a concept.  If the taxpayer is an accrual basis corporation then not having any accounts receivable, no matter the amount, is material.  The accounts receivable being overstated by $50,000 might not be; with a client who makes $200 million in sales annually.

Yes, the perfectionist says adjust the books.  I say only adjust if it is going to make a difference.  Yes, the amount doesn’t agree to something but who says that something is actually correct?

In our opinion, the excellent practitioner of his or her art starts with an entirely different premise.  They start by asking, “What is the purpose of this work?”  They frame the end game.  The perfectionist starts by asking, “What is wrong with what I am looking at?”

Which is why I think many people have difficulties choosing professionals to help them.  Lets face it, we choose a tax practitioner based on the claim of the largest refund, i.e. the perfectionist.  Never mind the fact that in order to gain a large refund you first had to pay it in.  We choose lawyers based on the claim they have never lost a case, because they always settle cases where there is the risk of loss.  Perfection.

Focus on excellent, on improvement.  Think about the bigger picture and then surround yourself with those who can support your vision.  You will be a happier person in the end.

Have an awesome day.

 

Motivation

One of the more challenging aspects of working from home is to stay motivated and on target.  And there are days where I know that some little step has to be performed and I simply can’t find the desire to do it.  It is 15 minutes out of my day to do something that can’t be avoided but never-the-less requires me to change gears to get it done.

The first thing I needed to do was admit there are times of the day where I am motivated to do things and other times when I am better off following an established pattern.  Writing for instance.  I always write these blogs first thing in the morning.  I am wired on caffeine and have lots of ideas flowing through my head.  I am motivated to get my thoughts down and honestly have a bigger problem with selecting a topic than with coming up with one.

I also recognize that one of the things that motivates me is solving difficult problems.  This is why I enjoy being an auditor and also love doing planning work.  As an auditor my role is to ferret out the truth and make sure that what is in a financial statement is accurate.  It demands a focus on details and putting puzzle pieces together.  Planning requires a passion to look at the bigger picture and oftentimes create the puzzle itself.

A quick segue on planning.  I am about 60% through a major revision of my planning workbook as of last evening.  It takes a model from going directly to consumer to working with middlemen.  Now I have to start filling in the concepts and giving those values.  For instance, going direct requires more marketing and advertising to build brand awareness whereas going through middlemen require more discounts and slotting payments to ensure the middleman gives a product enough love and attention.  And all this to determine how much working capital may be required to get a dream off the ground.

I rely upon mental discipline to do things like tax preparation.  Mental discipline is not the same as motivation although it can ultimately help you get the job done.   I get incredible satisfaction doing audits and working on planning and almost zero finishing a tax return.  I can, however, slog through dozens of returns with no errors and perhaps even flashes of insight but really, I would be ok if I never saw another tax return in my life.

For me, I do the things I enjoy early and late.  I save mid-day for the discipline stuff.  Finishing a blog provides me enough positive energy to get through a few required tasks and then I can finish the day theorizing and documenting how a 2 point change in price might influence a buyers decision.

So, if you find something that gives your work meaning try to find out how to use it to get the other parts of your job completed.  I suggest always starting with a motivating step and then following that with something you find less-motivating.  And then maybe take a break and do something to reward yourself.  For me its the gym but you may want to go to a little coffee shop and read a book for an hour.  Whatever you need to do to get all those little things done when your motivation lags.

Have a great day and enjoy the work.  If you have questions or would like to comment feel free to write me anytime.  And if you are looking for an advisor through your harder business decisions, I would love the opportunity to be of service to you.