Initial SFFAS 54 Implementation Considerations for Federal Agencies

WARD MELHUISH: Thank you for joining our session today with LeaseQuery to introduce the federal leasing standard, Statement 54. My name is Ward Melhewish. I'm the Managing Director with Cherry Bekaert and lead our federal government sector advisory group.

WARD MELHUISH: With the federal leasing standard implementation date rapidly approaching, we're going to introduce the standard, review the phases of implementation, highlight how a software solution can help collect the required information, and share best practices and tips from others who are implementing the leasing standard. We will also have time at the end to answer questions.

WARD MELHUISH: To receive CPE credit, you must answer at least three polling questions and attend for the full 50 minutes. CPE certificates will be issued via email within 10 days. If you have not received yours after 10 days, please email cbh learning at cbh.com. A recorded version of this webinar will be available in about one week and will be sent out via email and posted to our website.

WARD MELHUISH: If you have any questions during the webinar, please type them into the Q&A window located in your control panel. A short survey will be posted at the conclusion of the webinar. We value your feedback and ask that you take part.

WARD MELHUISH: I'm pleased to introduce our two knowledgeable speakers, Danny Martinez and Jason Parker. Danny is a director with Cherry Bekaert and is the accounting advisory lead for our government and public sector practice. As a CPA and Certified Government Financial Manager, Danny brings 15 years of audit experience and is well versed in FASAB accounting, grants management, Single Audit, peer review, and GASB 87.

WARD MELHUISH: Jason is a senior alliance manager at LeaseQuery and formerly LeaseQuery's lead solution consultant. Jason is an active CPA in the State of Georgia. Prior to joining LeaseQuery, Jason spent several years at KPMG in the external audit practice serving both public and private clients across a wide range of verticals.

WARD MELHUISH: For today's agenda, Danny will introduce Statement 54 and discuss the phases of implementation. Jason will address gathering required lease information. Both Danny and Jason will share lessons learned from GASB and FASB implementations.

WARD MELHUISH: Our first polling question: What is your primary purpose for attending today's webinar? Choices: interesting topic, need to implement the standard, knowledgeable presenters, CPE credit, or another reason.

WARD MELHUISH: There is a new article Danny has written on the lease accounting standard on our Cherry Bekaert website.

WARD MELHUISH: Looking at the polling results, about a third need to implement, a third need CPE credit, and others cited knowledgeable presenters and an interesting topic. At this point, I will turn it over to Danny.

DANNY MARTINEZ: Thank you, Ward, and thank you to everyone attending today. Whether you are attending live or viewing the archived version, we appreciate your time.

DANNY MARTINEZ: As Ward covered, we will do a few things today but not everything related to Statement 54. The way we built this presentation mirrors a kickoff call our advisory group would have: enough information about Statement 54 to understand what you're dealing with and a walkthrough of the phases of implementation, from initial learning to obtaining required financial statement journal entries and disclosures.

DANNY MARTINEZ: Statement 54 is effective for reporting periods beginning after September 30, 2023, so many entities will be implementing for fiscal year 2024.

DANNY MARTINEZ: Statement 54 places a large number of leasing transactions on the balance sheet that previously may have been disclosed only in the notes. The standard moves away from the operating versus capital lease distinction to a single lease framework. This standard is similar to the GASB standard followed by state and local governments, addressing both lessee and lessor perspectives.

DANNY MARTINEZ: Early adoption is not permitted for Statement 54, but you should not wait until the implementation period to start planning. Implementation is prospective as of the adoption date, so you will not restate prior periods; however, you must review leases in place at the beginning of the implementation period and identify which arrangements meet the definition of a lease as of that date.

DANNY MARTINEZ: Identifying all lease transactions, including older contracts, can take time. Even though implementation is prospective, if an agreement still exists at the adoption date and meets the lease definition, you must include it. This step is often time-consuming.

DANNY MARTINEZ: To help wrap your head around what a lease is under Statement 54, let's look at the definition. A lease is defined as a contract or agreement whereby one entity conveys the right to control the use of property, plant, and equipment to another entity for a period of time specified in the contract or agreement in exchange for consideration.

DANNY MARTINEZ: This definition pulls parts from other lease definitions to fit federal government needs. Key elements to consider are: contract or agreement, the right to control, period of time, and exchange for consideration.

DANNY MARTINEZ: Contract or agreement focuses on legal enforceability. The definition includes agreements because intra-governmental leases are often referred to as lease agreements. Do not assume an arrangement is out of scope simply because the contract header does not say "lease." Evaluate whether an asset is being conveyed under the definition.

DANNY MARTINEZ: Right to control is central. FASAB issued Technical Release 20, which addresses implementation questions and covers the control concept. The guidance uses two criteria: A) the right to obtain the economic benefits or services from use of the underlying asset, and B) the right to control access to those economic benefits or services. These criteria create a spectrum of control scenarios that require judgment.

DANNY MARTINEZ: Period of time excludes indefinite arrangements. You must determine the period committed to using the asset as specified in the contract. Later webinars and articles will dig deeper into lease term and lease payments, including options to extend or terminate.

DANNY MARTINEZ: When learning and accumulating leases, specific agreement details may be less important initially, but key concepts include lease term, lease payments, optionality, and probability of exercising options.

DANNY MARTINEZ: Lease term is how long you committed to using the asset. Lease payments are amounts you committed to pay—fixed or fixed in substance. Some agreements include variable components based on performance or usage; for initial recognition, you focus on fixed or fixed-in-substance amounts.

DANNY MARTINEZ: Optionality matters. If you have options to extend or terminate, determine whether those options are probable of being exercised. In federal accounting literature, probable means more likely than not. If an extension is probable, include it in the lease term. This judgment will depend on factors such as operational needs and contractual terms.

DANNY MARTINEZ: Implementation often uncovers contract provisions you did not realize existed, such as unusual cancellation clauses. Reviewing agreements can be revealing.

DANNY MARTINEZ: "In exchange for consideration" means the entity receives something in return—monetary or non-monetary, including in-kind services. The low threshold for consideration means many arrangements may meet the lease definition. Materiality is important: you must capture the entire population to determine what is immaterial individually and in aggregate.

DANNY MARTINEZ: Short-term leases are excluded from balance sheet presentation under Statement 54. A short-term lease is a term of 24 months or less as of the implementation date. Revenue and expense are recorded normally, but nothing is recognized on the balance sheet.

DANNY MARTINEZ: Intra-governmental leases between consolidation entities defined by Statement 47 must be included in the implementation process but are excluded from balance sheet presentation. You will record revenue and expense and provide required note disclosures. Paragraphs 26 through 38 of the standard address this treatment.

DANNY MARTINEZ: Other definitions that help calculate the lease liability include lease incentives, lease concessions (such as rent holidays), reduced rents, leasehold improvements, lessor improvements, and initial direct lease costs. We will provide the presentation PDF so you can reference these definitions and the standard directly.

DANNY MARTINEZ: Next polling question: Given this definition of a lease, how many leases do you estimate your organization has? Choices: 0–25, 26–100, 101–500, 500+, or I have no idea. This includes both lessee and lessor activity.

DANNY MARTINEZ: I respect the honesty of "no idea." Our goal today is to help you and your agencies better understand where you may land.

DANNY MARTINEZ: Now I will discuss the phases of implementation. I lead government and public sector accounting advisory, and much current work is related to lease implementation. Statement 54 incorporates much from GASB 87 with tweaks for federal governments, so many concepts carry over.

DANNY MARTINEZ: We use four phases of implementation: Phase 1 — gain an understanding of the statement and identify key stakeholders; Phase 2 — identify the complete lease population; Phase 3 — develop policies and procedures and identify systems; Phase 4 — reporting, disclosure, and go-forward processes. Today we are focusing mainly on phases one and two.

DANNY MARTINEZ: Phase 1: Obtain training on Statement 54, meet internal stakeholders to determine lease exposure, and design an implementation team. Lease implementation requires substantial effort, engagement, and training of cross-functional teams, improved internal controls and systems to maintain a complete universe of leases and related data, extensive data capture, and consideration of materiality for asset capitalization thresholds and disclosures.

DANNY MARTINEZ: Communicate broadly. If you have not issued messaging about the program-wide impact, templates and communications can help convey the scope and urgency.

DANNY MARTINEZ: Phase 2 is the most variable in duration. When asked how long implementation takes, my response is: how long will it take for you to feel comfortable you've found all leases? Begin compiling known leases, use checklists, and share guidance with departments that can enter into lease transactions.

DANNY MARTINEZ: Translate accounting language into operational terms for those handling day-to-day transactions. Ask operational questions: did you enter a transaction that could last more than 24 months in one day? Does it relate to property, plant, and equipment—something tangible you can move or touch? Capture these broadly.

DANNY MARTINEZ: The biggest audit risk is completeness. Casting a wide net is essential.

DANNY MARTINEZ: Search for embedded leases—contracts with a leasing component and a service component. Examples include buildings with janitorial services, copiers with maintenance and supplies, and other bundled arrangements. Identifying embedded leases can be challenging.

DANNY MARTINEZ: Use data analytics to scan the general ledger for potential leasing transactions. Look for patterns such as periodic equal payments, vendor names suggesting leasing arrangements, and GL descriptions that could indicate property, plant, and equipment. We have teams that can assist with data analytics.

DANNY MARTINEZ: Collect all relevant information and document procedures to ensure completeness. You may start with a large contract population and reduce it as you apply scope and materiality. Document the journey from the initial population to those included in the scope of Statement 54 for auditor review.

DANNY MARTINEZ: Phase 3: Update policies and procedures for leasing transactions. Add new general ledger accounts as needed, capture new leases entered in fiscal year 2024, and document processes for reassessment and remeasurement for extensions, impairments, or early terminations. Define how probable options to extend or terminate will be evaluated.

DANNY MARTINEZ: Identify a software solution or other method to perform calculations and produce journal entries and disclosures. Ensure the GL is set up with accounts to record the required debits and credits.

DANNY MARTINEZ: Many clients want to jump straight to booking entries. Implementation is a journey through the phases. Success at the end of the process is having journal entries and required footnotes and disclosures that explain why lease assets and liabilities appear on the balance sheet.

DANNY MARTINEZ: Polling question: Which area concerns you most with implementation? Choices: finding all leases (completeness), identifying tools and resources including software, updating policies/procedures/controls, getting journal entries and disclosures correct, or no idea.

DANNY MARTINEZ: We have a Q&A chat box for questions. Jason and I will share our contact information on the last slide.

DANNY MARTINEZ: It looks like finding all leases is the leading concern, followed by journal entries and accounting. Thank you for your responses. I will now turn the presentation over to Jason to cover gathering required lease information.

JASON PARKER: Thank you, Danny. That was an excellent rundown of the steps an advisory group like Cherry Bekaert would take to begin the adoption process.

JASON PARKER: For those concerned about identifying leases, once you identify the full lease population, the next step is obtaining appropriate details from contracts. Many of these details are judgmental; it is not simply extracting data from contracts and booking entries. I'll discuss what information is necessary to determine journal entries.

JASON PARKER: On the lessee side, Statement 54 requires recognition of a lease liability measured at the present value of lease payments expected to be made throughout the term. Lease payments consist of more than base rent; several payment types must be considered. When you recognize that lease liability, subsequent payments reduce the liability and the difference between the payment and the principal portion is interest, recognized as interest expense based on the discount rate you identify.

JASON PARKER: Discount rate is judgmental and often not provided by the lessor. We will cover how to identify an appropriate discount rate.

JASON PARKER: Lease payments to include as a lessee: fixed payments such as base rent that you are certain to owe. Variable payments dependent on an index or rate—if a payment depends on an index like CPI, you initially measure it assuming the index remains at its measurement date level.

JASON PARKER: Variable payments that are fixed in substance should be included. For example, a percentage of sales with a contractual minimum is treated as fixed to the extent of the minimum. Residual value guarantees that are probable of being owed must be included; estimate residual value at term end and include any expected shortfall as a final payment in the present value calculation.

JASON PARKER: Purchase options included when it is probable the lessee will exercise them. When we say probable, we typically advise around a 90 percent threshold if using percentages. Include any purchase price you expect to pay.

JASON PARKER: Termination penalties are included unless an availability of funds clause or cancellation clause precludes including the penalty. Lease incentives receivable from the lessor are netted against payments and reduce the opening liability. Include any other payments probable of being required.

JASON PARKER: The corresponding debit to the lease liability is the right-of-use (ROU) leased asset. The initial ROU asset generally starts at the same value as the lease liability, with possible adjustments such as prepayments, lease incentives received before commencement (which reduce the ROU asset), and initial direct costs (which increase the ROU asset).

JASON PARKER: Prepayments made before the lease commencement increase the ROU asset because they defer expense recognition to the lease term. Lease incentives received before commencement reduce the ROU asset to avoid recognizing an expense for amounts already received. Initial direct costs to place the lease asset into service are capitalized into the ROU asset and amortized over the term.

JASON PARKER: On the lessor side, you recognize a lease receivable measured at the present value of lease payments expected to be received, with a corresponding unearned revenue liability recognized net. The lessor recognizes interest on the lease receivable based on the discount rate charged to the lessee, recorded as interest revenue. Lessors should reduce lease payments by any provision for uncollectible amounts where applicable.

JASON PARKER: Included in the lessor present value calculation are fixed payments, variable payments dependent on an index or rate, variable payments fixed in substance, residual value guarantees probable of being received, and lease incentives payable to the lessee, which reduce the capitalized lease receivable.

JASON PARKER: Initial direct costs are not relevant on the lessor side. Lease payments received ahead of time increase unearned revenue, which is then recognized as revenue systematically and rationally over the term, typically on a straight-line basis unless another pattern is more appropriate.

JASON PARKER: Discount rate identification is judgmental. Lessors typically know the rate charged. Lessees often do not know the implicit rate in the lease and may lack the fair value of the underlying asset. If you cannot identify the implicit rate, the estimated incremental borrowing rate should be used.

JASON PARKER: For federal entities, the Department of the Treasury borrowing rate for securities with similar maturities to the lease term is generally appropriate unless the entity has its own borrowing authority. Consider whether leases are similar enough to group for borrowing rate estimation.

JASON PARKER: Lessons learned from GASB and FASB implementations: start immediately. Entities often find leases they did not realize qualified as leases because not every arrangement is labeled as a lease. Completeness takes much more time than expected.

JASON PARKER: I'll hand it back to Danny for additional lessons and comments.

DANNY MARTINEZ: Thanks, Jason. Local governments had similar experiences with ASC 842, and many found implementation took longer than expected. Starting early is important, and do not go it alone; make this an organization-wide effort and leverage external assistance when needed.

DANNY MARTINEZ: Jason and I have been working on this topic for several years. We could dive into many stories and challenges, which may be the subject of future webinars. For now, we'll move to the final polling question.

JASON PARKER: We discussed advisory support options. Implementation is more than journal entries; planning is required to adopt appropriately. Options include co-sourcing and assistance with technology to ensure long-term compliance and ease of reflecting terminations, impairments, and modifications.

DANNY MARTINEZ: Cherry Bekaert and LeaseQuery have a GSA MAS contract, which helps address contracting challenges for this type of assistance.

WARD MELHUISH: Thank you, Jason and Danny, for your insights and valuable tips. We have a couple minutes left. If there are any other questions, please put them in the chat box.

WARD MELHUISH: Danny, one question: when you discussed embedded leases and used copiers as an example, is there a threshold value for what qualifies as PP&E for a lease under the standard? For example, are printers too small?

DANNY MARTINEZ: There is no value threshold for whether an arrangement meets the lease definition. As long as it meets the definition of property, plant, and equipment and the lease criteria, it is a lease. However, you may apply materiality; you need not apply the standard to immaterial items. Materiality thresholds vary by organization, so evaluate term length, aggregate exposure, and what is material for your agency or department.

WARD MELHUISH: That concludes our session. Thank you for attending and thank you, Danny and Jason, for your insights. If you have additional questions, please send them to us. Contact information for Danny and Jason appears on the last slide.

WARD MELHUISH: We value your feedback and ask that you take part in the short survey that appears when you leave the session. Thank you very much.