Clarifying the Requirements Under the New Lease Accounting Rules

1. Page 0July 18, 2013
Prepared for Georgia HFMA Summer Institute
Georgia HFMA
2013 Summer Institute
Clarifying the Requirements under the
Proposed Lease Accounting Rules
and
Accounting for ICD-10 Implementation Costs
July 18, 2013
Doug Arnold, CPA – PYA Principal

2. Page 1July 18, 2013
Prepared for Georgia HFMA Summer Institute
Leases: Where We Are Now
• FASB Statement No. 13, Accounting for Leases,
was issued in 1976 and created the basic
framework we currently use for lease accounting
– For perspective, the current lease standard is a
contemporary of:
• The founding of Apple Computer

3. Page 2July 18, 2013
Prepared for Georgia HFMA Summer Institute
Leases: Where We Are Now
• The movies Rocky, Taxi Driver, and Carrie (the original
one)
• Jimmy Carter being elected President of the United
States

4. Page 3July 18, 2013
Prepared for Georgia HFMA Summer Institute
Leases: Where We Are Now
• Statement No. 13 specifies that a lessee should
recognize both an asset and a liability for a lease
that transfers substantially all benefits and risks
associated with the ownership of the property
– Currently, this is what is known as a “capital lease”

5. Page 4July 18, 2013
Prepared for Georgia HFMA Summer Institute
Leases: Where We Are Now
• Criteria for capital leases:
1) The lease transfers ownership of the property to the lessee
by the end of the lease term
2) The lease contains a bargain purchase option
3) The lease term is equal to 75% or more of the estimated
economic life of the leased property
4) The present value of minimum lease payments at the
beginning of the lease term equals or exceeds 90% of the
fair value of the leased property at lease inception

6. Page 5July 18, 2013
Prepared for Georgia HFMA Summer Institute
Leases: Where We Are Now
• The asset and liability will initially offset each other
on the balance sheet
• The asset recorded under a capital lease is typically
grouped in the “Property, Plant, and Equipment”
(PP&E) section of the entity’s balance sheet
• The asset is depreciated (amortized) like any other
depreciable fixed asset
• The liability recorded under a capital lease is
typically recorded in debt

7. Page 6July 18, 2013
Prepared for Georgia HFMA Summer Institute
Leases: Where We Are Now
ASSETS LIABILITIES AND EQUITY
CURRENT ASSETS CURRENT LIABILITIES
Cash 10,000$ Accounts payable 1,000$
Inventory 4,000 Accrued payroll 3,000
14,000 4,000
CAPITAL ASSETS LONG-TERM LIABILITES
Land 8,000 Long-term debt 50,000
50,000 Capital lease liability 5,000
Capital lease asset 5,000 55,000
63,000
EQUITY 18,000
77,000$ 77,000$
TOTAL CURRENT LIABILITIES
TOTAL LONG-TERM LIABILITIES
BALANCE SHEET - CAPITAL LEASE
TOTAL ASSETS
TOTAL CAPITAL ASSETS
TOTAL CURRENT ASSETS
TOTAL LIABILITIES AND EQUITY
Equipment

8. Page 7July 18, 2013
Prepared for Georgia HFMA Summer Institute
Leases: Where We Are Now
REVENUE
Patient revenue, net 50,000$
Other 5,000
TOTAL REVENUE 55,000
EXPENSES
Depreciation 1,500
Interest 1,500
Lease expense -
Supplies 1,000
Salaries and other 10,000
TOTAL EXPENSES 14,000
NET INCOME 41,000$
INCOME STATEMENT - CAPITAL LEASE

9. Page 8July 18, 2013
Prepared for Georgia HFMA Summer Institute
Leases: Where We Are Now
• Statement No. 13 also specifies that if a lease does
not transfer substantially all benefits and risks
associated with the ownership of the property, it
should be treated as an operating lease
• An operating lease is not recorded on the balance
sheet. Rather, as lease payments are made, an
entry is made to debit lease (or rental) expense
• Operating lease payments for future periods are
disclosed in a footnote to the financial statements

10. Page 9July 18, 2013
Prepared for Georgia HFMA Summer Institute
Leases: Where We Are Now
REVENUE
Patient revenue, net 50,000$
Other 5,000
TOTAL REVENUE 55,000
EXPENSES
Lease expense 3,000
Supplies 1,000
Salaries and other 10,000
TOTAL EXPENSES 14,000
NET INCOME 41,000$
INCOME STATEMENT - OPERATING LEASE

11. Page 10July 18, 2013
Prepared for Georgia HFMA Summer Institute
Leases: Where We Are Now
• The following is an example operating lease disclosure taken
from HCA’s 12/31/12 10-K:
Note 12 – Leases
We lease medical office buildings and certain equipment under operating lease agreements.
Commitments relating to noncancellable operating leases for each of the next five years and thereafter
are as follows (dollars in millions):
301$
283
225
178
145
870
2,002
(44)
1,958$
2016
2015
2014
2013
Less sublease income
For the Year Ended December 31,*
Thereafter
2017
*Financials taken from SEC’s Edgar Website

12. Page 11July 18, 2013
Prepared for Georgia HFMA Summer Institute
A (Very) Brief History of
the Leases Joint Project
• In June 2004, the International Accounting
Standards Board (IASB) and the FASB agreed that
lease accounting was in need of an overhaul
• In August 2010, the first Proposed Accounting
Standards Update (PASU) on leases was released.
Not well received

13. Page 12July 18, 2013
Prepared for Georgia HFMA Summer Institute
A (Very) Brief History of
the Leases Joint Project
• This brings us to the present. On May 16, 2013, the
FASB released a revised version of the 2010 PASU
on lease accounting
• One driver behind revised lease guidance is that
many financial statement users felt that the current
treatment was not presenting a fair representation of
all lease transactions
• The biggest criticism relates to the fact that operating
leases do not require an entity to recognize an asset
or a liability

14. Page 13July 18, 2013
Prepared for Georgia HFMA Summer Institute
A (Very) Brief History of
the Leases Joint Project
• Oftentimes an entity is able to work with the lessor to
structure a lease in such a way that it qualifies as an
operating lease and thus is kept “off the books”

15. Page 14July 18, 2013
Prepared for Georgia HFMA Summer Institute
A (Very) Brief History of
the Leases Joint Project
• Many airlines had few airplanes recorded on their
balance sheets
Average
Seating Capital Operating
Equipment Type Capacity Owned Leased Leased Total
American Airlines Aircraft
Boeing 737-800 153 86 - 109 195
Boeing 757-200 181 81 2 23 106
Boeing 767-200 ER 168 4 9 2 15
Boeing 767-300 ER 218 45 - 13 58
Boeing 777-200 ER 247 44 3 - 47
Boeing 777-300 ER 310 - - 2 2
McDonnell Douglas MD-80 140 106 19 66 191
Total 366 33 215 614

16. Page 15July 18, 2013
Prepared for Georgia HFMA Summer Institute
A (Very) Brief History of
the Leases Joint Project
• For healthcare entities, this could be especially
important since capital leases often factor into an
organization’s calculation of financial debt covenants
associated with existing debt while operating leases
do not

17. Page 16July 18, 2013
Prepared for Georgia HFMA Summer Institute
What’s New
• For leases with a maximum possible term of more
than 12 months, a lessee would be required to
recognize an asset and liability
• The lessee would recognize a liability to make lease
payments and a right-of-use asset representing its
right to use the leased asset (the underlying asset)
for the lease term
• Lessor accounting will also be impacted

18. Page 17July 18, 2013
Prepared for Georgia HFMA Summer Institute
What’s New
• A lease for less than 12 months would be treated in
a similar fashion to how we currently treat operating
leases
• The subsequent accounting for a lease greater than
12 months will be based upon its classification as
either a Type A or a Type B lease. The classification
as Type A or B is based upon the nature of the
leased asset. Classification not reassessed unless
contract is modified

19. Page 18July 18, 2013
Prepared for Georgia HFMA Summer Institute
Type A Leases
• If the underlying asset is not property (defined as
land or a building, or part of a building, or both), a
lessee would classify the lease as a Type A lease
– However, if the lease term is for an insignificant
part of the total economic life of the underlying asset
or the present value of the lease payments is
insignificant relative to the fair value of the
underlying asset at the commencement date, it
would be classified as a Type B Lease

20. Page 19July 18, 2013
Prepared for Georgia HFMA Summer Institute
Type A Leases
• If the lease is determined to be a Type A lease, a
lessee would:
• Recognize a right-of-use asset and a lease liability,
initially measured at the present value of lease
payments
• Recognize the unwinding of the discount on the lease
liability as interest separately from the amortization of
the right-of-use asset which is to be amortized on a
straight-line basis, with certain exceptions

21. Page 20July 18, 2013
Prepared for Georgia HFMA Summer Institute
Type A Leases
• The following are example journal entries related to
recording Type A leases
– To record the lease asset and liability:
• DR Right-of-use asset XXX
• CR Lease liability XXX

22. Page 21July 18, 2013
Prepared for Georgia HFMA Summer Institute
Type A Leases
• If the lessee expects to consume the right-of-use
asset’s future economic benefits evenly on the
straight-line basis, this entry would be recorded to
recognize lease expenses:
• DR Interest expense XXX
• CR Lease liability XXX
• DR Amortization expense XXX
• CR Right-of-use asset XXX

23. Page 22July 18, 2013
Prepared for Georgia HFMA Summer Institute
Type B Leases
• If the underlying asset is property, a lessee would
classify the lease as a Type B lease. However, if the
term of the lease is for the major part of the
remaining economic life of the underlying asset or
the present value of the lease payments account
for substantially all of the fair value of the
underlying asset at the commencement date, it
would be classified as a Type A Lease

24. Page 23July 18, 2013
Prepared for Georgia HFMA Summer Institute
Type B Leases
• If the lease is determined to be a Type B lease, a
lessee would:
• Recognize a right-of-use asset and a lease liability,
initially measured at the present value of lease
payments (Same as a Type A Lease)
• Recognize a single lease cost, combining the
unwinding of the discount on the lease liability with the
amortization of the right-of-use asset, on a straight-line
basis

25. Page 24July 18, 2013
Prepared for Georgia HFMA Summer Institute
Type B Leases
• The following are example journal entries related to
recording Type B leases
– To record the lease asset and liability:
• DR Right-of-use asset XXX
• CR Lease liability XXX

26. Page 25July 18, 2013
Prepared for Georgia HFMA Summer Institute
Type B Leases
• The following entry is made to record the lease
expense when a payment is due:
• DR Lease expense XXX
• CR Lease liability XXX
• CR Right-of-use asset XXX

27. Page 26July 18, 2013
Prepared for Georgia HFMA Summer Institute
Insignificant Portion
of Economic Life
• Unfortunately, the PASU does not specifically define
what is considered to be the insignificant portion of
the economic life
• Several examples are provided, however:
– A lease of three years for a car that has an economic
life of seven years is considered to be significant

28. Page 27July 18, 2013
Prepared for Georgia HFMA Summer Institute
Insignificant Portion
of Economic Life
– A lease of two years for an office floor in a building
that has an economic life of 50 years is considered to
be insignificant

29. Page 28July 18, 2013
Prepared for Georgia HFMA Summer Institute
Discount Rate
• An entity should use the rate (either explicit or
implicit) that the lessor charges the lessee as the
discount rate used to initially determine the present
value of lease payments

30. Page 29July 18, 2013
Prepared for Georgia HFMA Summer Institute
Options to Extend the Lease Term
• At the commencement date of a lease, an entity
assesses whether the lessee has a significant economic
incentive to exercise, or not to exercise, an option
• An entity’s assessment should consider contract-based,
asset-based, market-based, and entity-based factors

31. Page 30July 18, 2013
Prepared for Georgia HFMA Summer Institute
Disclosures
• An entity would be required to provide expanded
disclosures to meet the objective of enabling users
of financial statements to understand the amount,
timing, and uncertainty of cash flows arising from
leases

32. Page 31July 18, 2013
Prepared for Georgia HFMA Summer Institute
Disclosures
• Information about the nature of the lease that could be
disclosed includes:
– A general description of the lease
– The basis on which variable lease payments are
determined
– The existence, and terms and conditions, of an option to
extend or terminate the lease, or purchase leased asset
– Any restrictions or covenants imposed by leases
– Reconciliations of opening/closing balances on balance
sheet

33. Page 32July 18, 2013
Prepared for Georgia HFMA Summer Institute
Retrospective Approach
• At the date the guidance becomes effective,
organizations are expected to recognize and
measure leases at the beginning of the earliest
period presented using either a full retrospective
approach or a modified retrospective approach

34. Page 33July 18, 2013
Prepared for Georgia HFMA Summer Institute
Full Retrospective Approach
• The full retrospective approach would require a lessee
to calculate the carrying amounts of all outstanding
leases individually at the date of transition as if those
leases had always been accounted for in accordance
with the proposed guidance

35. Page 34July 18, 2013
Prepared for Georgia HFMA Summer Institute
Modified Retrospective Approach
• The modified retrospective approach would require
a lessee to calculate lease assets and liabilities in a
manner similar to the full retrospective approach,
but the lessee would be allowed to use information
available at the date of transition and would be able
to calculate a discount rate on a portfolio basis for
leases with similar characteristics rather than
calculate a specific discount rate for each individual
lease

36. Page 35July 18, 2013
Prepared for Georgia HFMA Summer Institute
Comment Period
• The comment period for this PASU ends September
13, 2013

38. Page 37July 18, 2013
Prepared for Georgia HFMA Summer Institute
Accounting for ICD-10
Implementation Costs
• Implementation of ICD-10 is mandatory by October
1, 2014 (delayed from October 1, 2013)
• Expands the number of diagnostic codes from
approximately 24,000 to greater than 155,000
• In July 2012, the AICPA issued Technical
Information Service Inquiries and Replies (TIS)
6400.48, Accounting for Costs Incurred During
Implementation of ICD-10

39. Page 38July 18, 2013
Prepared for Georgia HFMA Summer Institute
Accounting for ICD-10
Implementation Costs
• Some interesting new ICD codes:
– R46.1 “Bizarre personal appearance”
– W22.02XA “Walked into lamppost, initial encounter”
– W22.02XD “Walked into lamppost, subsequent
encounter”
– V91.07XA “Burn due to water-skis on fire”

40. Page 39July 18, 2013
Prepared for Georgia HFMA Summer Institute
Accounting for ICD-10
Implementation Costs
• The AICPA has identified four “major” types of costs
associated with the implementation of ICD-10:
– Modify existing computer systems to make them ICD-
10 compliant, or else replace those systems that
cannot be made ICD-10 compliant
– Enhance electronic medical records
– Train clinical coders to use ICD-10
– Train clinicians to improve their documentation so
that the information necessary to bill under ICD-10 is
available

41. Page 40July 18, 2013
Prepared for Georgia HFMA Summer Institute
Accounting for ICD-10
Implementation Costs
• The guidance in ASC 720-45 is applicable in
considering how to best account for ICD-10
implementation costs
• Project costs should be segregated amongst:
– Process reengineering activities
– Activities that develop or modify software
– Costs associated with the acquisition of fixed assets

42. Page 41July 18, 2013
Prepared for Georgia HFMA Summer Institute
Accounting for ICD-10
Implementation Costs
• Costs associated with process reengineering
(examination of business office workflow and tasks,
for example) are expensed as incurred
• Costs associated with developing or modifying
internal-use software can either be capitalized or
expensed based on FASB’s internal-use software
guidance
• Costs associated with the acquisition of fixed assets
are accounted for in accordance with an entity’s
fixed asset capitalization policy

43. Page 42July 18, 2013
Prepared for Georgia HFMA Summer Institute
Accounting for ICD-10
Implementation Costs
• If an outside consultant is hired by the healthcare
provider to conduct the entity’s ICD-10
implementation, the price of the consulting project
should be allocated (and either expensed or
capitalized, as appropriate) based on the values of
each “type” of work performed

44. Page 43July 18, 2013
Prepared for Georgia HFMA Summer Institute
Accounting for ICD-10
Implementation Costs
• ASC 720-45-55-1 provides the following table
outlining which items can, and cannot, be
capitalized

45. Page 44July 18, 2013
Prepared for Georgia HFMA Summer Institute
Accounting for ICD-10
Implementation Costs

46. Page 45July 18, 2013
Prepared for Georgia HFMA Summer Institute
Accounting for ICD-10
Implementation Costs
• Per ASC 350-40-25, it is important to remember that
all training costs should be expensed as incurred,
even if those costs are incurred during the
application development stage
• ASC 350-40-25 also states that costs to modify
software should only be capitalized when the
modifications result in “additional functionality”
• Costs that only pertain to routine maintenance
should be expensed as incurred

47. Page 46July 18, 2013
Prepared for Georgia HFMA Summer Institute
Accounting for ICD-10
Implementation Costs
• Assessing “additional functionality”

48. Page 47July 18, 2013
Prepared for Georgia HFMA Summer Institute
Accounting for ICD-10
Implementation Costs
• The best course of action is to discuss what costs
can and cannot be capitalized with your auditors
ahead of time
• As a public service announcement on behalf of
auditors everywhere, please do not wait until after
the end of the year to begin the discussion on what
costs should be capitalized versus those that should
be expensed

49. Page 48July 18, 2013
Prepared for Georgia HFMA Summer Institute
Questions?
Contact information for Doug Arnold
(800) 270-9629
darnold@pyapc.com