Remarks before the 2017 AICPA Conference on Current SEC and PCAOB Developments
Michael P. Berrigan, Professional Accounting Fellow, Office of the Chief Accountant
Dec. 4, 2017
The Securities and Exchange Commission (“SEC” or “Commission”) disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author's views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.
Good morning and thank you for the opportunity to speak with you today. This morning I will provide an update on the Office of the Chief Accountant’s (“OCA”) efforts with respect to implementation of the new leases standard, including my observations related to certain consultation requests received by OCA as well as some observations related to entities’ lease implementation activities.
The staff’s involvement in the implementation of the new leases standard has focused on actively monitoring implementation efforts and continued dialogue with stakeholders to discuss emerging accounting questions identified as a result of their implementation progress. Conclusions provided by OCA to date, primarily relate to scoping and transition issues. Today I’d like to share my observations on two of these consultations to illustrate the types of questions raised to OCA and how OCA has thought about the issues.
Lease Transition — Minimum Rental Payments
The first transition topic I will discuss relates to the lessee’s determination of remaining minimum rental payments for purposes of the lessee’s transition entry upon the adoption of ASC 842, for arrangements historically accounted for as operating leases. The transition guidance in ASC 842 requires the lessee to initially measure the lease liability using the remaining minimum rental payments (as defined by ASC 840). One accounting question raised to the staff related to whether the lessee’s initial lease liability recognized in transition, should include or exclude the portion of the fixed, gross rental payments that represent executory costs, such as insurance, maintenance and/or taxes. Registrants sought clarification from the staff on this issue as the measurement of the lease liability recognized in transition is directly impacted by the entity’s determination of remaining minimum rental payments.
It was observed that under existing GAAP, some lessees currently account for the entire rental payment as a minimum lease payment while others exclude from the minimum lease payment the portion representing executory costs connected with the leased asset. Some registrants concluded that executory costs should be included in minimum rental payments in transition consistent with their existing accounting policy to include executory costs as a portion of minimum lease payments under ASC 840. Those expressing this view asserted that “remaining minimum rental payments” should be derived from the definition of “minimum lease payments” in ASC 840, which they historically viewed as inclusive of payments attributable to executory costs as the guidance in ASC 840 refers to executory costs as a portion of minimum lease payments. Alternatively, others concluded that executory costs should be excluded from minimum rental payments consistent with their existing accounting policy to exclude executory costs from minimum lease payments under ASC 840. Those expressing this view generally agreed that the “remaining minimum rental payments” should be derived from the definition of “minimum lease payments” but concluded that executory costs were excluded from minimum lease payments as they viewed the guidance in ASC 840 as emphasizing the exclusion of executory costs from minimum lease payments.
In considering each view, the staff observed that the term “minimum rental payments” is not explicitly defined in ASC 840. As a result, the staff did not object to registrants consistently applying their historical accounting policy conclusions regarding the composition of minimum lease payments when concluding whether executory costs should be included in remaining minimum rental payments for purposes of establishing the lease liability in transition.
Lease Transition — Incremental Borrowing Rate
Another transition topic addressed by the staff relates to the incremental borrowing rate a lessee should apply when measuring the lease liability in transition. The transition guidance for lessees clearly states that upon adoption, the lessee should measure the lease liability using the discount rate established as of the beginning of the earliest period presented in the financial statements or the commencement date of the lease, if later. However, registrants observed that the transition guidance does not specify whether the discount rate selected should be based on the original lease term or the remaining lease term.
Some registrants concluded that the lessee should select a discount rate based on the original lease term as they believe that rate better reflects the borrowing rate embedded within the contract when the lessee entered into the arrangement. Other registrants concluded the lessee should select a rate based on the remaining lease term as they believe the rate more accurately reflects the rate applicable to the remaining lease liability recognized in transition. The staff observed that the transition guidance does not specify the lease term that should be used to determine the discount rate and further observed that either rate used in transition may significantly differ from the rate that would have been determined at commencement of the lease (i.e. the original commencement date of the lease). The staff concluded that the selection of either of these rates, that is either the rate based on the original lease term or the remaining lease term, is reasonable and ultimately did not object to a registrant’s consistent application of either approach to determine the lessee’s lease liabilities in transition.
Importance of Careful Implementation Planning
Additionally, I’d like to reiterate the importance of thoughtful planning and timely implementation of the leases standard. My colleagues in OCA have given several speeches that provide their observations on the lease standard. To further this message, I’d like to share the following observations that may be helpful as each of you continue, or prepare for, your implementation efforts:
First, the identification of contracts that represent or contain a lease is a key step. While, to be clear, entities are not required to begin implementation efforts today, I would encourage entities to continue or begin efforts to identify the population of relevant contracts and evaluate whether or not those arrangements are, or contain a lease. I believe, this step is necessary to fully assess the scope of contracts subject to the new standard. Once the complete inventory of contracts is identified and analyzed, I believe a company can among other items, better assess the additional level of effort required for implementation.
Second, the transition guidance for the standard differs from the guidance applied on a go-forward basis under ASC 842. The Board acknowledged that the accounting applied in transition will not be the same as that applied under ASC 842 prospectively. I would encourage entities to educate themselves on these differences during implementation and continue to follow the Financial Accounting Standards Board’s (“FASB”) recent standard setting activities to allow sufficient time to gather relevant information to apply both the transition and general provisions of the standard.
Third, careful implementation planning, management, and oversight are necessary. Leveraging lessons observed from the revenue implementation efforts, I encourage entities to plan and manage lease implementation activities to allow for adequate time to formulate reasonable judgments in the application of the standard and evaluate any necessary changes in Internal Control over Financial Reporting (“ICFR”) that will be required to support ASC 842. As a reminder, the OCA staff is available and welcomes dialogue (on a formal or informal basis) as questions arise as a result of your implementation process. Guidance for those requesting consultation with the Office of the Chief Accountant can be found on the SEC website.
In closing, thank you for the opportunity to share my observations with you today and I look forward to continued dialogue in the year ahead.
 Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842) (Feb. 2016).
 See Sagar Teotia, Deputy Chief Accountant, Office of the Chief Accountant, U.S. Securities and Exchange Commission, Addressing Implementation Matters to Improve Financial Reporting (Sept. 21, 2017), available at https://www.sec.gov/news/speech/speech-teotia-2017-09-21.
 Accounting Standards Codification (“ASC”) 842-10-65-1(l)
 See ASC 840-10-25-1(d) and illustrative capital lease disclosures at ASC 840-10-55-40.
 See ASC 840-10-25-1(d) and illustrative operating lease disclosures at ASC 840-10-55-40.
 ASC 842-10-65-1(l)
 To illustrate, assume an entity previously entered into a 20 year lease with total payments of $20 million and that the remaining lease term as of the earliest date presented in the financial statements upon adoption of ASC 842 is five years with remaining payments of $5 million. The question raised is whether it is appropriate for the entity to select the discount rate applicable as of the date of the first period presented in the financial statements based on an original lease term (for example, the rate applicable for a 20 year borrowing with payments of $20 million) or the remaining lease term (for example, the rate applicable for a five year borrowing with payments of $5 million).
 E.g., Ruth Uejio, Professional Accounting Fellow, Office of the Chief Accountant, U.S. Securities and Exchange Commission, Remarks Before the 2016 AICPA National Conference on Current SEC and PCAOB Developments (Dec. 5, 2016), available at https://www.sec.gov/news/speech/uejio-2016-aicpa.html; Wesley R. Bricker, Chief Accountant, Office of the Chief Accountant, U.S. Securities and Exchange Commission, Remarks Before the 2017 Baruch College Financial Reporting Conference: Advancing Our Markets with High-Quality Information (May 4, 2017), available at https://www.sec.gov/news/speech/remarks-2017-baruch-college-financial-reporting-conference-advancing-our-capital; Sagar Teotia, Deputy Chief Accountant, Office of the Chief Accountant, U.S. Securities and Exchange Commission, Addressing Implementation Matters to Improve Financial Reporting (Sept. 21, 2017), available at https://www.sec.gov/news/speech/speech-teotia-2017-09-21; Wesley R. Bricker, Chief Accountant, Office of the Chief Accountant, U.S. Securities and Exchange Commission, Remarks before the Financial Executives International 36th Annual Current Financial Reporting Issues Conference: Effective Financial Reporting in a Period of Change (Nov. 14, 2017), available at https://www.sec.gov/news/speech/speech-bricker-2017-11-14.
 See ASU 2016-02, Basis of Conclusions (“BC”) paragraph 391 (acknowledging that the accounting result from applying the required modified retrospective transition approach will not be the same as that from a full retrospective approach).
 See FASB Tentative Board Decisions (Nov. 29, 2017) (discussing the board’s proposal to issue a proposed Accounting Standards Update for amendments to be made to Topic 842), available at http://www.fasb.org/cs/ContentServer?c=FASBContent_C&pagename=FASB %2FFASBContent_C%2FActionAlertPage&cid=1176169472980.