Impact of the New Lease Standard on Healthcare Entities
The financial reporting and operational impact of this new lease standard could be significant for healthcare entities. Having to recognize lease-related assets and liabilities could affect management’s decisions over the organization’s capital expenditures and debt or investment activity. ASC 842 will also impact an organization’s financial ratios and compliance with certain debt covenants. Healthcare entities will need to be mindful of this new lease standard to ensure they have the necessary accounting policies and internal controls in place to effectively implement the new ASC and communicate its financial impact to key stakeholders.
ASC 842 is effective for public business entities and certain not-for-profit entities that have issued securities or are conduit bond obligors for annual periods beginning after December 15, 2018, and interim periods within those years. For all other entities, it is effective for annual periods beginning after December 15, 2019, and interim periods the following year. Early adoption is permitted for all entities. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period presented in the financial statements.
ASC 842 applies to leased property, plant and equipment, including subleases of those assets. ASC 842 does not apply to the following leases:
- Leases of intangible assets
- Leases of inventory
- Leases of assets under construction
- Leases of biological assets
- Leases to explore natural resources
Definition of a Lease
Topic 842 defines a lease 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. Control over the use of the identified asset means that the customer has both (1) the right to obtain substantially all of the economic benefits from the use of the asset and (2) the right to direct the use of the asset.
Identifying and separating components of a contract
The new lease standard requires an entity to separate the lease components from the non-lease components (for example, maintenance services or other activities that transfer a good or service to the customer) in a contract. Activities that do not transfer a good or service to the lessee or amounts paid solely to reimburse costs of the lessor are not components in a contract and are not allocated any of the consideration in the contract.
An example of a healthcare entity with lease and non-lease components would be an organization that enters into a contract with another entity to lease medical equipment to the lessee and obtains a license for intellectual property. The lessee would allocate the contract consideration to the lease of medical equipment as the lease component and the license as the non-lease component. The license would be accounted for as an intangible asset.
Healthcare entities must be mindful that the new lease standard will require the disclosure of both qualitative and quantitative information regarding their leases.
Qualitative information that will be required to be disclosed under the new lease standard includes the following:
- Information about the nature of the healthcare entity leases
- Information about leases that have not yet commenced, but that create significant rights and obligations for the lessee
- Information about the significant judgments and assumptions made in accounting for leases
- Whether an accounting policy election was made for the short-term lease exemption; and
- Lease transactions with related parties
The following quantitative information will also need to be disclosed:
- Maturity analysis of lease liabilities/investments
- Lease expense/income
- Sublease income, disclosed on a gross basis
- Weighted average remaining lease term
- Weighted average discount rate
- Net gain or loss recognized from sale and leaseback transactions; and
- Supplemental noncash information on lease liabilities arising from obtaining right-of-use assets
Organizations impacted by the new lease standard should be proactive in obtaining the necessary information to ensure disclosures of both quantitative and qualitative data surrounding their leases.
Preparing for Adoption
Healthcare entities should consider forming an implementation team to spear-head efforts in implementing the new lease standard. Suggested steps for the implementation team include informing key stakeholders on the expected impact to the financial statements and any changes the ASC will have on the organization’s financial covenants. The implementation team should also perform a preliminary assessment as soon as possible to determine a health care entity’s available resources for tracking leasing activities and to perform an inventory of existing lease contracts, especially for all previously reported operating leases.
To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.