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The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2021-07, Compensation-Stock Compensation (Topic 718) titled “Determining the Current Price of an Underlying Share for Equity-Classified Share-Based Awards.”

The amendments in this update affect all nonpublic entities that issue equity-classified share-based awards and elect the practical expedient in this update.

What’s in the Update?

A nonpublic entity can now determine the current price input of equity-classified share-based awards issued to both employees and nonemployees using the reasonable application of a reasonable valuation method.

The practical expedient describes characteristics of the reasonable application of a reasonable valuation method. These include:

  1. The date on which a valuation’s reasonableness is evaluated
  2. The factors that a reasonable valuation should consider
  3. The scope of information that a reasonable valuation should consider
  4. The criteria that should be met for the use of a previously calculated value to be considered reasonable

These characteristics are the same as those identified by the Internal Revenue Service for income tax purposes that results in a valuation commonly referred to as a “409A report.” And the update specifies that an analysis that complies with IRS rules will also achieve this practical expedient. Examples of what can be used include:

  1. A valuation determined by an independent appraisal within the 12 months preceding the grant date
  2. A valuation based on a formula that, if used as part of a non-lapse restriction with respect to the shares, would be considered the fair market value of the shares
  3. A valuation made reasonably and in good faith that is evidenced by a written report that considers the relevant factors with respect to the illiquid stock of a start-up corporation, as defined in the regulations

The update is effective for fiscal years beginning after December 15, 2021, and it can be adopted earlier.

What This Means for Technology Start-Ups

Before this ASU, accountants and auditors were required, in some cases, to perform significant additional analysis and assessments above and beyond 409A reports to ensure the current value input used to calculate stock option expense was reasonable. Now, this is not necessary. This change will allow virtually all 409A Reports to be used to determine the current value input when calculating stock option expense with little additional analysis.

Have questions on how the update may affect your organization? Contact a Clark Nuber professional to discuss further.

Emma Tsuber, Audit Manager at Clark Nuber PS

Emma Tsuber is a senior manager in Clark Nuber’s Audit and Assurance Services Group. 

© Clark Nuber PS and Developing News, 2022. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Clark Nuber PS and Developing News with appropriate and specific direction to the original content.

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You Received a Shuttered Venue Operators Grant, What’s Next for Your Company?

If you are reading this article, you may be one of the thousands of business owners who received a Shuttered Venue Operators Grant (SVOG) this year and are feeling overwhelmed by the implications this new grant has on your compliance requirements. This article is intended to provide an overview of what to consider when your for-profit entity receives an SVOG. If you are a not-for-profit or other non-federal entity as defined under the Uniform Guidance, please find more information in this Clark Nuber article.

What is the SVOG?

The SVOG program was established by the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act, and amended by the American Rescue Plan Act. The program includes over $16 billion in grants to shuttered venues administered by U.S. Small Business Administration’s (SBA) Office of Disaster Assistance. In summer of 2021, eligible applicants were encouraged to apply for this grant equal to 45% of gross earned revenue, with the maximum amount available for a single grant award of $10 million. The application portal was closed to new applicants on August 20, 2021. As of December 13, 2021, $13.5 billion has been disbursed in initial and supplemental grants to 12,816 recipients across the country, with $2.5 billion still budgeted for distribution.

What Are the New Compliance Implications?

There are allowable cost restrictions, requirements for reporting, etc. that are outlined by the SBA’s website, Applicant User Guide, and Frequently Asked Questions. These materials provide a guide for how to be in compliance with the grant, including one particular detail which has big implications -- if your company expended more than $750,000 of federal funds within its fiscal year, you will now be subject to one of two compliance requirements. Either:
  1. You must receive a Single or Program-Specific Audit consistent with Uniform Guidance Subpart F (2 CFR 200. 500 – 521); or
  2. You must receive a financial statement audit of the award in accordance with Government Auditing Standards (GAS)
Unless a business is already accustomed to receiving financial statement audits under GAS, we expect most to opt for Option 1. To determine if your business exceeds this $750,000 threshold, let’s look at the methodology for recognizing this revenue. The relevant guidance for this type of cost reimbursement federal award falls under U.S. GAAP ASU 2018-08Clarifying Guidance for Contributions Received and Contributions Made (Topic 958-605). This standard may be a new one to some business owners, and a familiar friend to not-for-profit entities. It clarifies that nonreciprocal revenue is to be recognized when the associated barrier to entitlement (condition) is met. We would consider there to be two conditions for this revenue to be recognized:
  1. You must receive your Notice of Award
  2. You must incur allowable costs, as defined by the legislation and the Uniform Guidance
As soon as you receive your notice of award, you may recognize all allowable costs incurred from March 1, 2020 through that date on that date, and defer what remains to be recognized as additional allowable costs are incurred. The following examples will assist in determining when your business should record the revenue: Revenue Recognition Example 1: Facts:
  • Company with 6/30/2021 year-end receives a Notice of Award of an SVOG grant of $2 million dated 6/29/2021.
  • The company will a) use $500,000 of expenses incurred during March 2020 through June 2021, and then b) the remaining $1.5 million on expenses to be incurred July 2021 through December 2021.
Revenue Recognition:
  • Given the fact pattern, the company will record revenue as follows: a) the $500,000 of past expenses will trigger revenue recognized of $500,000 in June 2021 (while the expenses were incurred prior to June 2021, revenue cannot be recognized any earlier than the date of the Notice of Award); and b) the remaining $1.5 million of expenses will trigger revenue recognition in each month those expenses are incurred.
  • The result is that the company records $500,000 of SVOG grant revenue in FY2021 and $1.5 million of SVOG grant revenue in FY2022.
Revenue Recognition Example 2: Facts:
  • Same fact pattern as Example 1, except the Notice of Award is dated 7/2/2021.
Revenue Recognition:
  • Given the fact pattern, the company will record revenue as follows: a) the $500,000 of past expenses will trigger revenue recognized of $500,000 in July 2021 (while the expenses were incurred prior to July 2021, revenue cannot be recognized any earlier than the date of the Notice of Award); and b) the remaining $1.5 million of expenses will trigger revenue recognition in each month those expenses are incurred.
  • The result is that the company records all $2 million of the SVOG grant revenue in FY2022.
Note that when you are calculating the allowable costs to apply to the SVOG, you will want to be careful not to “double dip” with other federal funding (see what this means and some exceptions in this Clark Nuber article). If, after determining the revenue to be recognized for the SVOG, the total expenditures applied in your fiscal year exceed $750,000, you will be subject to one of the two audit requirements described above.

I Need a Single Audit — What Does the Process Look Like?

A Single Audit is a financial statement and federal awards’ audit of a non-federal entity that expends $750,000 or more in federal funds in one year. It is there to provide assurance to the federal government that an organization has adequate internal controls in place and is in compliance with program requirements. Generally speaking, most types of for-profit commercial entities are excluded from the requirement to receive a Single Audit. However, clarifying guidance was released by the SBA which scoped the recipients of the SVOG into this requirement. The auditor follows a prescribed testing approach as outlined in the Uniform Guidance (2 CFR 200) and the related Compliance Supplement. The Single Audit may be performed by your current audit firm if they meet the competency requirements in Government Auditing Standards. Single Audits are generally due the earlier of 30 days after report issuance for submission within nine months after your fiscal year end, however an extension was granted by the Office of Management and Budget (OMB) for entities with a June 30, 2021 year-end. They have until September 30, 2022 to file their Single Audit results. In planning for your Single Audit, the first thing your auditors will ask for you to provide is a Schedule of Expenditures of Federal Awards (SEFA). Your SEFA will include information regarding the entity’s SVOG award and any other federal awards expended during the fiscal year, including the related assistance listing number and amount expended, as calculated based on the revenue recognition guidance above. Using the fact patterns found in the revenue recognition examples earlier in the article, let’s see how the entity’s costs translate to the SEFA. SEFA Example 1:
  • This company will prepare its annual SEFAs using the amounts of revenue recognized. Accordingly, the FY2021 SEFA will report $500,000 for the SVOG and the FY2022 SEFA will report $1.5 million for the SVOG.
  • Assuming this company has no other federal awards, a Single Audit will only be required for FY2022.
SEFA Example 2:
  • This company will prepare its annual SEFAs using the amounts of revenue recognized. Accordingly, the FY2021 SEFA will report $0 for the SVOG and the FY2022 SEFA will report $2.0 million for the SVOG.
  • Assuming this company has no other federal awards, a Single Audit will only be required for FY2022.
Depending on the makeup of your SEFA once it is compiled, your entity may have one of two options in how to go about this audit:
  1. “Full Scope” Single Audit - In the case that your SEFA includes federal funding from more than one federal agency, a full scope Single Audit is required. Under the Uniform Guidance, your auditor is required to evaluate your SEFA to select “major programs” for testing, using a prescribed selection methodology. Under this methodology, it is more than likely that the SVOG will be the only major program that your auditors need to apply testing procedures over. Other funding that is not determined to be a “major program” by your audits will not require detailed compliance and control testing. One implication of having a “full scope” Single Audit performed is that this reporting must be accompanied by audited financial statements.
  1. Program-Specific Audit - You may find yourself in a position that the SVOG is the only federally funded grant you received during the year, in which case you may be eligible to receive a program-specific audit as defined in the Uniform Guidance (2 CFR 200.507). Under a program-specific audit, your auditor would have the same responsibility of testing the grant as a major program, without the additional step of needing to submit your financial statement audit.
The following flowchart clarifies if, and when, one of these audit types would come into play: Flowchart describing SVOG audit requirements

What Does the Testing for a Major Program Entail?

In testing the SVOG as a “major program,” your auditor will likely be interested in testing the compliance and controls over the following compliance activities:

1. Allowable Costs and Activities

Are the costs and activities applied to the grant allowable as defined by legislation and the Uniform Guidance, and is this supported with adequate documentation? Your auditor will be required to make selections from a detailed schedule of costs applied to determine if they all represent allowable costs and activities. To determine if a cost is allowable, the entity must refer to the SBA publications. The allowable costs under the SBA may be further constrained by limitations stipulated in the Uniform Guidance. For example:
  • While the SBA allows for all payroll costs to be applied to the grant, the Uniform Guidance (2 CFR 200.442) states that the costs of fundraising, including payroll, are not allowable unless the grantee obtains prior written approval from the awarding agency.
  • While the SBA allows for other ordinary and necessary business expenses, including maintenance costs, the Uniform Guidance disallows activities like lobbying (2 CFR 200.450), certain types of incentive compensation (2 CFR 200.430), and others.

Notes on Payroll Costs

Payroll costs are likely to be the most significant cost types applied to your SVOG. Payroll costs must be supported by a system of internal control which provides reasonable assurance that the charges are accurate, allowable, and properly allocated. These costs should:
  1. Be incorporated into the official records of the non-federal entity.
  2. Reasonably reflect the total activity for which the employee is compensated by the non-federal entity, not exceeding 100% of compensated activities;
  3. Encompass federally assisted and all other activities compensated by the non-federal entity on an integrated basis, but they may include the use of subsidiary records as defined in the non-federal entity’s written policy;
  4. Comply with the established accounting policies and practices of the non-federal entity; and
  5. Support the distribution of the employee’s salary or wages among specific activities or cost objectives if the employee works on more than one federal award; a federal award and non-federal award; an indirect cost activity and a direct cost activity; two or more indirect activities which are allocated using different allocation bases; or an unallowable activity and a direct or indirect cost activity.

2. Applicable Compliance Period

Were all costs applied incurred in the applicable compliance period? The SBA stipulates that funds may be applied to costs incurred as early as March 1, 2020. If an entity receives only an initial round of funding from the SBA, funding may be applied to costs incurred through December 31, 2021. If an entity receives a supplemental round of funding, the entity may apply costs incurred through June 30, 2022. Auditors will be looking to test a sample of costs to determine that they were incurred during the applicable time period. FAQ 141 from the SBA clarifies that the cash basis of accounting is allowable in addressing this compliance requirement.

3. Procurement Standards

Do applicable costs meet Procurement Standards as defined by the Uniform Guidance? Some non-payroll costs are also subject to compliance with procurement standards. Costs not subject to procurement standards include rent, utility payments, scheduled mortgage or debt payments, state and local taxes and fees, operating leases in effect as of February 15, 2020, and insurance payments. Costs typically subject to procurement standards include worker protection expenditures; payments to independent contractors; some administrative costs; and some advertising, production transportation, and capital expenditures related to producing a theatrical or live performing arts production. If any of these costs are in excess of the micro purchase threshold ($10,000), then there are prescribed methods for procurement at specified levels such as sealed bid, competitive, and noncompetitive proposal. Please see Clark Nuber’s OMB Uniform Guidance on Administrative Requirements – Update for Procurement Standards article for more detail on these types of procurements. For purchases below the $10,000 threshold, the purchase may be awarded without competition if the entity determines the price to be reasonable. When determining if the entity has any purchases in excess of the micro purchase threshold, keep in mind the threshold applies to the aggregate of purchases from each vender, not an individual invoice or purchase order.

4. Accurate and Timely Reporting

Is all reporting required under the legislation submitted accurately and timely? Grantees are required to submit a SF-425 report upon closeout of the grant with the SBA, within 14 days of receiving notification. Your auditors will be interested in reviewing that reporting accurately reflects the details of how the grant was used.

My Single Audit is Done! Now What?

The results of your Single Audit will be uploaded to the Federal Audit Clearinghouse and are publicly available. This upload package includes the Single Audit Report and the related audited financial statements, if applicable.

What Do I Have to Consider for My Tax Return?

As is common with different relief programs implemented during the COVID-19 pandemic, special rules apply to the tax treatment and reporting of SVOG funds and expenses applied to SVOG. Unless an exception applies, gross income for tax purposes includes all sources of income. In the case of SVOG funding, the Consolidated Appropriations Act of 2021 (PL 116-260) established that revenue received from the SVOG program is not included in gross income for federal income tax purposes. In addition, expenses applied to SVOG are deductible on a federal income tax return, though taxpayers should use caution when using the same payroll costs for SVOG and the employee retention tax credit (ERTC). For all of 2020 and the first two quarters of 2021 the same payroll may be applied to both programs. The amount of the retention credit, however, is not eligible for a federal income tax deduction. Therefore, even if payroll costs are allowed as an income tax deduction under the SVOG program, those same costs may not be ultimately deductible on the taxpayer’s federal income tax return because of the ERTC rules. Taxpayers with state income tax filing requirements should verify treatment of SVOG revenue and expenses with each state. There is no requirement that states follow the federal treatment of SVOG revenues and expenses, and states vary in approach. For partnerships and S Corporations, SVOG is treated as tax-exempt income. Thus, SVOG increases a partner’s basis in its partnership interest, and, for S Corporations, increases a shareholder’s basis in the S Corporation’s stock. In addition, SVOG increases a S Corporation’s accumulated adjustments account (AAA).

Following Up on Your SVOG

SVOG awards were an important financial lifeline to businesses during this tumultuous time in our economy. Now, it’s important to get the accounting of those funds correct. If you have any questions regarding how to recognize revenue, how to navigate a Single Audit, or anything else related to the SVOG you received, please reach out to a Clark Nuber professional. Laura Becker, Audit and Assurance Manager at Clark Nuber Laura Becker is a manager in Clark Nuber's Audit and Assurance Services Group. © Clark Nuber PS, 2021. All Rights Reserved.

Is Your Data Safe in the Cloud?

During a recent meeting we had with an organization, we asked their director if they had assessed the cybersecurity of the personally identifiable information they obtained from donors and employees. She replied, “We don’t need to worry about that, it isn’t on our servers. It’s in the cloud.” Unfortunately, we had to inform her that, if the cloud service provider was hacked, her organization would share liability for the compromised data. And the penalties would include having to provide credit insurance, possible fines and penalties, and the hit to their reputation. On top of all that, there will always be elements of security that you’re fully responsible for, such as determining who should have the appropriate level of access to sensitive data in your organization.

How to Protect Your Data in the Cloud

So, what should you be doing to protect data that is stored in the cloud?

1. Be Selective in Who You Entrust With Your Sensitive Data

Do your due diligence work before selecting a vendor to make sure it is a reputable business with a good track record of security.

2. Make Sure You Have Your Own Security House in Order

Even if data is stored in the cloud, it can still be accessed from your computers if they are compromised. Use a professional to help you make this assessment, unless you have qualified in-house IT staff.

3. Make Sure Your Cloud Service Providers Have Good Controls in Place to Safeguard Your Data

This can be accomplished by asking them for what is known as a System and Organization Controls (SOC) report. Your vendors should be hiring outside experts to test their security controls, and the results of this testing will be summarized in the SOC report. Once you have obtained the reports, you have to read them. Are there any findings in the report that would cause you to rethink entrusting them with your data? If you don’t feel qualified to read and understand the SOC report, you can outsource this function.

4. Understand Roles and Responsibilities Between You and the Cloud Provider

Statements of work, service level agreements, and SOC reports define what you’re responsible for versus what the cloud provider will do for you. For example, cloud providers will provide you tools to further secure accounts with multi-factor authentication. However, it is your responsibility to actually enforce multi-factor authentication on all cloud accounts. Another example would be that cloud providers provide monitoring tools, such as to prevent or detect unwarranted network traffic. It is up to your organization to actively monitor that. Finally, there will always be processes that you’re fully responsible for; for example, ensuring that only appropriate individuals have access to sensitive data. The cloud vendor would not be in a position to determine whether Jill from the accounting department should be allowed to modify sensitive data. It is unlikely that any cloud provider will fully assume your cybersecurity risk.

5. Formalize This Process to Ensure That It Is Not Just Done Once and Forgotten

How often you do this process is a function of risk. How much sensitive data does a given vendor hold? What would be the impact if it was compromised? For higher-risk data, you may want to examine security access annually. For others, your policy may require it be done every two to four years.

6. Consider Cyber Insurance if You Work With a Lot of Sensitive Data

These policies are relatively inexpensive and can help with credit monitoring and PR issues as well as shoring up your system.

7. Consider Adding SOC Report Clauses to Your Contracts With Cloud Service Providers

Adding a SOC report clause to your contracts ensures your third party vendor is responsible for staying up to the latest codes.

Next Steps

Whether it is your general ledger software provider, payroll processing company, or donor database software vendor, it is up to you to ensure these companies are properly safeguarding the data that has been given to you. According to the Association of Certified Fraud Examiners, cyber fraud is the number one type of fraud currently. Taking the actions above can help make sure your sensitive data in the cloud doesn’t fall victim to malicious hackers. If you’d like to discuss your organization’s cybersecurity, contact one of our IT Services team members. © Clark Nuber PS, 2022. All Rights Reserved.

Implementing the New FASB Lease Accounting Standard: Identifying the Lease

As discussed in our previous article, now is the time to begin the process of implementing Accounting Standards Update No. 2016-03, Leases (Topic 842). The first step companies must take to effectively implement the new FASB lease accounting standard is reviewing all significant contracts and agreements to determine if the contract, or part of the contract, falls within the scope of the new standard and contains a lease. The majority of agreements will be easily identifiable as a lease based on the nature and/or terms of the agreement and the underlying asset (e.g., office space, vehicles, copiers). However, with changes to vendor service offerings and the structure of purchasing in today’s economy, certain contracts may fall within the scope of the new lease standard that may not be obvious. To properly identify all lease agreements and other contracts containing leases, companies should take a step back and look at all agreements in place and consider the terms of the individual contracts in light of the definition of a lease under Topic 842. This will help determine if the contract meets the definition of a lease, requiring application of the new standard.

Definition of Lease

Under the new standard, a lease is defined as, “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.” Now, let’s break this definition down.

What is an Identified Asset?

Assets will typically be explicitly defined within the contract (e.g., legally defined property). Intangible assets, rights to explore for or use natural resources, biological assets, inventory, and assets under construction are not considered identified assets within the scope of the lease standard. A contract for a portion of an asset qualifies as an identified asset if it is physically distinct (e.g., a specific space in a building or a specific segment of a pipeline). If the asset is not physically distinct and the leasing entity does not have rights to substantially all output of the asset (e.g., a fraction of capacity on fiber optic cable), the asset is not considered physically distinct and, therefore, the contract would not fall within the scope of the new standard. In certain circumstances, an asset would be considered implicitly identified when the lessor only has one asset which would satisfy the contract. Furthermore, the agreement may allow for substitution of the asset throughout the term of the contract and still be considered an identified asset. If substitution provisions are included in the agreement, the terms will need to be reviewed to determine if the right to substitute is substantive. See Right to Control below for considerations in determining whether control is lost due to a substitution provision.

What is a Period of Time?

A period of time may be a set time period or set amount of use of an identified asset (e.g., output allowed within the contract), as agreed on within the contract.

What is Considered the Right to Control?

An entity is deemed to have control over the use of the identified asset if, for all or a portion of the contract period, the entity has both:
  1. the right to obtain substantially all of the economic benefits from the use of the asset
  2. the right to direct the use of the asset

Obtaining Economic Benefit

Using, holding, or subleasing an asset and/or the asset’s output and byproducts all provide economic benefit. Many lease agreements provide for the exclusive use of the identified asset, in which case the leasing entity has the right to substantially all of the economic benefit. In evaluating whether the leasing entity has rights to substantially all economic benefits, the entity should evaluate the economic benefits within the terms of the contract. If the contract specifies a portion of an asset or other contract limitations, only that specified portion should be considered in evaluating whether the contract provides for substantially all benefits.

Directing the Use of the Asset

The right to direct the use of the asset is provided when a leasing entity is provided the right under the contract to determine when, how, and for what purpose the asset is used throughout the contract term. Or, in the event the use of the asset is predetermined within the contract, the leasing entity is considered to have the right to direct the use of the asset if the lessor cannot change that predetermined use. Lastly, if the leasing entity designed all or a part of the asset in such a way that the purpose and timing of use are predetermined, the leasing entity essentially has the right to direct to the use of the asset, based on its ability to design the asset for specific use.
Protective Rights
The contract may include limitations on the use of the identified asset to protect the lessor’s interest in the asset, its personnel, or to ensure compliance with laws and regulations. These protective rights clarify the use allowed under the contract but alone are not considered to impair the leasing entity’s right to direct the use of the asset over the contract period. Protective rights may limit the geographical area, distance, amount of use (e.g., mileage on a vehicle), or operating practices required for the asset. In considering whether the leasing entity has the right to control the asset, the economic benefits and use of the asset should be evaluated within the confines of the limited rights. For example, if the lease provides for use of the asset only within a specific region, the leasing entity should evaluate whether it has the right to substantially all economic benefits and to direct the use of the asset within that specific region only. If the leasing entity has exclusive use of the asset and can determine when, how, and for what purpose the asset is used within the specific region allowed within the contract, the leasing entity would conclude it has the right to control the asset. Protective rights limiting the use of an asset do not prevent the leasing entity from directing the use of the asset under the terms of the agreement.
Substitution Rights
As discussed above, most leases will specifically define the asset provided under the agreement; however, in certain circumstances, the lessor may have the right to substitute the asset throughout the lease term. If the asset is subject to substitution throughout the term of the contract, leasing entities must determine whether the right is considered a substantive right. The lessor is considered to have a substantive right if they have both:
  • the ability to substitute the asset
  • the lessor would benefit economically from such substitution
If a lessor has a substantive right to substitute the asset, the entity is deemed to not have the right to control the use the identified asset and would not qualify as a lease under the new standard. This determination is made at the inception of the lease. Any future events which are unknown or unlikely at inception of the lease (e.g., subsequent changes to asset value or changes in consumer demand) should not be considered in evaluating whether the lessor would benefit from substitution. Assets held onsite of the leasing entity are less likely to provide the lessor with an economic benefit in the event of substitution due to the cost of substituting the asset at the customer’s site. Substitutions resulting from required repairs and maintenance or upgrades available throughout the term of the lease may be provided within the contract and still allow for the asset to qualify as an identified asset. If the leasing entity cannot reasonably determine whether the lessor has a substantive right, the leasing entity would conclude no such right exists and, subject to other requirement previously discussed, account for the contract as a lease.

Accounting Policy Elections

The new standard provides for several accounting policy elections to ease the burden of implementing and accounting for leases under the standard. A few key elections available for determining whether a lease qualifies as falling within the scope of the new standard relate to short-term leases and leases falling below the entity’s capitalization policy.

Short-Term Leases

Entities can elect to not recognize lease assets and liabilities for a lease with a term of 12 months or less, provided the lease does not include an option to purchase the asset or extend the lease which the entity is reasonably certain to exercise. If the entity expects to exercise a purchase option or exercise an option to extend the lease term, the lease should not be excluded based on the short-term exemption alone. Entities wishing to adopt this provision will make an accounting policy election and must apply the short-term exemption consistently across all leases within each asset class. While leases excluded from recognition under this election will not be required to be recorded on the balance sheet with a right-of-use asset and lease liability, these leases will remain subject to disclosure requirements, including disclosing short-term lease costs incurred. Entities should continue to track expenses associated with these agreements to ensure disclosures are properly made within its financial statements.

Capitalization Policies

Similar to capitalization policies elected for capitalizing or expensing a purchased asset, entities may elect not to account for a lease that is considered immaterial to the financial statements. In setting a capitalization policy, an entity should consider its financial situation, the lease contract(s) in question, and the users of its financial statements to ensure the policy elected will provide for materially accurate financial reporting. One approach to setting a capitalization threshold for a lease contract is to set a liability threshold and evaluate whether the lease liability for the lease contract in question exceeds such threshold. If the lease liability exceeds the threshold, the lease would be accounted for under the new standard with a right-of-use asset and lease liability. If the liability does not exceed the threshold, the lease would not be recorded on the balance sheet but rather expensed as incurred. Typically, in determining whether a lease meets the capitalization threshold, a net approach (netting the asset with the related liability) should not be taken.

Identifying Your Leases

With the understanding of what constitutes an asset and when the contract is (or contains) a lease, here are a few practical steps to finding all leases held by your company:
  • Review annual detail of all rent and lease expense accounts to see which vendors and contracts are included within your current rent and lease expense accounts. Gather any supporting contracts for those expenses and review the contract to determine if it is (or contains) a lease.
  • Identify your company’s significant service contracts and review the agreements for any components which could be considered leased assets.
  • Discuss with personnel involved in procurement activities. Provide an overview of what constitutes a lease to key personnel responsible for procurement of goods and services for your company and brainstorm whether any other agreements could fall within the definition of a lease.

Summary

While identifying the majority of leases will be straightforward, significant judgment and analysis will be needed in evaluating some agreements. Consider all relevant facts and circumstances of the arrangement when determining whether the contract meets the definition of a lease. This flowchart can be used to walk through the individual tests in considering whether the terms of the contract meet the definition of a lease. If the contract does meet the definition, it should be accounted for in accordance with the new lease accounting standards.

Want to Learn More?

This article highlights the key terms of identifying a lease within a contract. In future articles, we will discuss lease and nonlease components, lease classification, recognition of lease assets and liabilities, and transition methods. In the meantime, please contact your Clark Nuber service team or Shelley Oswald if you would like to discuss the new standard’s impact on your business and contracts. © Clark Nuber PS, 2022. All Rights Reserved.

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