New Lease Standard for Healthcare Entities
Oct 15, 2019 09:38AM
By MED Magazine
The new lease standard from the Financial Accounting Standards Board (FASB) was released in February 2016. With it came sweeping changes with direct impact for several types of organizations and industries, including healthcare entities.
The standard includes components on operating leases, implementation options and more. The FASB and other standard-setting bodies have been discussing updating lease accounting for over a decade, which was probably necessary, as the original lease standard had been in place since 1975.
Other provisions of the new lease standard will require organizations to carefully review leases for what is termed lease components versus non-lease components (for example, maintenance services or other services). The non-lease components should be accounted for in accordance with other guidance. Maintenance services, for example, would be expensed as a period expense as incurred. There is a practical expedient within the guidance for an entity to make an accounting election to not separate lease components from non-lease components, but that will increase the lease liability initially recorded, so organizations should carefully review the implications of this accounting election.
Definition of a Lease
A lease has been defined as “a contract, or part of a contract, that conveys the right to control the use of an identified asset (the underlying asset) for a period of time in exchange for consideration.” The following two criteria are required to be met to conclude that a contract contains a lease:
- The use of an identified asset is either explicitly or implicitly specified. A contract does not involve the use of an identified asset if a supplier has the substantive right to substitute the asset used to fulfill the contract.
- The customer controls the use of the identified asset; i.e., the lessee has the right to direct the use of the identified asset and obtain substantially all of the benefits of doing so throughout the period of use.
The Impact of the New Lease Standard on Healthcare Entities
For healthcare entities, there is a unique consideration due to some of the types of lease agreements that have been developed. A primary example is lab equipment that the healthcare entity received for free after purchasing a certain level of reagent or other supplies within a certain timeframe. This type of arrangement is what is termed an embedded lease, and the agreement will need to be carefully reviewed to determine the lease component—likely, a right-of use-asset and lease liability will be recorded. There are other examples of this type of arrangement with radiology, IV pumps, etc.
The guidance in ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, for nonprofits that have issued or are conduit bond obligors for securities that are traded, listed, or quoted on an exchange or an over-the-counter market. For all other entities, the new lease standard is effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. It is worth noting that in July 2019, FASB voted to propose delaying the effective date for these entities by one year.
How Healthcare Entities Can Adopt the New Lease Standard
Early application is permitted for all entities either for the period beginning after December 15, 2018 (i.e. calendar year 2019 would be the first required to adopt) or the period beginning after December 15, 2019 (i.e. calendar year 2020). Please work with your auditors to determine which group your healthcare facility falls into.
The first step in adopting the provisions of ASU 2016-02 would be to create a process, which may include a committee, software solution or even just a defined plan, to help in the identification of all agreements that are either leases (operating or financing) or agreements that may have embedded leases. It will likely increase success if you involve various department managers. A complete list of leases, including agreements that have embedded leases, is necessary to ensure that ASU 2016-02 is properly implemented. One way to assist in creating a complete listing is to cross-check agreements against monthly expenses recorded. This should not be the only process, however, as embedded leases will generally not show up in lease or rental expense categories.
Once the list has been assembled, the agreements need to be reviewed to determine lease versus non-lease components. After that analysis has been completed, your organization should be in a position to determine if electing the accounting policy to not separate lease components from non-lease components is appropriate.
For some organizations, especially those with significant operating leases and/or embedded leases, there will be a significant amount of right-of-use assets and lease liabilities that will need to be calculated and recorded upon adoption.
What Healthcare Entities Can Do Now with the New Lease Standard
With all the discussion that has been focused on the changes in revenue recognition, which are generally effective for organizations the year before the lease standard, ASU 2016-02 has possibly taken a backseat. This standard will take some time for organizations to adopt, so it is important that you start planning for this now. As you do, be sure to focus on agreements in excess of one year and not just “leases” in order to identify all possible embedded lease arrangements.