When a lessor that provides a tenant improvement allowance to a lessee owns the resulting leasehold improvements, the lessee generally does not recognize the allowance as income or have a depreciable interest in the improvements. A: The answer depends on how the lease is classified and whether the package of transition practical expedients is elected. 657980 Chairwoman Kelly, Ranking Member Gutierrez and Members of the Subcommittee: I am pleased to appear before you on behalf of the Securities and Exchange Commission ("SEC" or "Commission") to testify concerning several accounting issues affecting the telecommunications industry. The steps are as follows: Start with the initial amount of the lease liability, computed by discounting the remaining lease payments + Outstanding balance of prepaid rent or In a network capacity contract or arrangement that meets the definition of a lease, the capacity provider is the lessor, and the capacity purchaser is the lessee. 179D energy-efficient commercial buildings deduction, IRS provides guidance on perfecting S elections and QSub elections. When adopting Topic 842, taxpayers should be aware that the standard does not change income tax accounting treatment for leases. This area of telecom accounting received considerable scrutiny following challenges of "hollow swapping" (transactions lacking commercial substance, but structured to achieve an accounting result). However, entities in this position should assess the accuracy of their lease measurement assumptions, such as the discount rate, identification of lease and nonlease components (if applicable), and allocation of contract consideration between the lease and nonlease components (if applicable). <> 1239 0 obj The interest cost of $55,056 will be taken to the statement of profit or loss as a finance cost. 13 See Financial Reporting Release No. These writtendeterminations may, however, offer an indication of the IRSs position on the issues addressed. %%EOF In the course of adopting Topic 842, taxpayers should review their income tax accounting methods for leasing-related items, including lease characterization (i.e., sale, lease, or financing), timing of rental income or expense under Sec. A remeasurement triggering event occurs, as outlined in the following table: A: Applying the impairment model in Topic 360 can be a complex assessment for lessees. x][s8~OU1C\InMdNL|vf-S%xq! 2016-02, Leases (Topic 842), which is effective for public companies for fiscal years and interim periods within fiscal years beginning after Dec. 15, 2018 (Dec. 15, 2021, for entities not meeting FASB's definition of a public business entity). endobj For lessors the finance and operating lease distinction and accounting remains largely unchanged. http://www.sec.gov/news/testimony/032102jmm.htm. " means an indefeasible right of use permitting Customerto have exclusive use of the Wave Lease: Under a Wave Lease, the tenant has an exclusive right to use a dedicated wavelength in a strand within the fiber optic cable over a specifically identified route for the term of the lease. Thus, rental income and expense are almost never reported on a straight-line basis as they are for book purposes. This incentive may be provided in different forms such as payment of the lessees costs, an up-front cash payment, or the assumption of the lessees current lease. endobj Under the new standard, a lessee evaluates whether a lease is classified as finance or operating at the commencement of a new lease and upon a change in the lease term or change in the lessees option to purchase the asset. by John M. Morrissey <> 1228 0 obj Telecommunications entities have been grappling with the accounting for long-term capacity arrangements ever since International Financial Reporting Standards came into widespread use, and a new standard issued in 2016 (IFRS 16) will soon add another layer of complexity. To the extent that nonmonetary exchange transactions have a significant impact on a registrant's liquidity, capital resources, or results of operations, disclosure of these transactions in MD&A would be required. Such a statement misleads investors when the company does not clearly disclose the basis of its presentation. The liability is equal to the present value of future lease payments. The 2 The maintenance cost is calculated on route miles, not strand miles. Capacity Lease: Under a Capacity Lease, the tenant has an exclusive right to . 343 0 obj <>/Encrypt 319 0 R/Filter/FlateDecode/ID[<967DD5BF40C25544BBC72810FB3D05A5><2C3DEFCB7C8BAE49A81E542B7502ECC4>]/Index[318 61]/Info 317 0 R/Length 118/Prev 184372/Root 320 0 R/Size 379/Type/XRef/W[1 3 1]>>stream Unless an impairment or modification has occurred, the ROU asset is subsequently measured in a similar manner as its initial measurement. Sample 1. Many credit agreements contain frozen GAAP provisions that indicate that changes in GAAP will not constitute a default or will require both parties to negotiate in good faith if technical default occurs as a result of the adoption of new GAAP. the new accounting treatment will immediately affect a range of key metrics monitored by stakeholders, including: Transparency in financial reporting, that is, the extent to which financial information about a company is available and understandable to investors and other market participants, plays a fundamental role in making our markets the most efficient, liquid, and resilient in the world. In addition to these changes in the accounting rules, as the industry evolved, many capacity providers changed their service offerings to permit more flexibility than was previously available in fixed, point-to-point capacity sales. endobj Because "pro forma" information is information derived by selective editing of financial information compiled in accordance with GAAP, companies should be particularly mindful of their obligation not to mislead investors when using this information. 1014 0 obj IRS private letter rulings concerning non-traditional real property for REIT income tests. endstream Two accounting issues have been addressed and resolved by the EITF that primarily relate to IRU accounting.8 Other issues on the EITF's current agenda could have an impact on the industry's accounting practices.9. 66 and No. 110 provides a limited exclusion from a lessee's gross income for a lessor's payment of a "qualified lessee construction allowance." The lease liability pertains to the obligation to make the rental payments using the present value of the future rental payment. 01-04, Accounting for Sales of Fractional Interests in Equipment, and EITF Issue No. Recent press articles have raised questions about the transparency of the accounting and disclosure practices followed by Global Crossing. 8.5 accounting aspects in which IRUs operate. This guidance, along with additional interpretive guidance provided by the FASB's Emerging Issues Task Force ("EITF"),7 has the general effect of rendering the assets subject to telecommunications capacity agreements as real estate for accounting purposes. 0 Determining asset groupings can require considerable judgment. Purchase of specified infrastructure No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. Determining asset groupings can require considerable judgment. Deputy Chief Accountant, U.S. Securities and Exchange Commission. )C7Me~?f~( R1B2IhV4/_lDv}d7B|_/_d>^fT4{*,+Ede/(dY/{{IHO>k.j}o.$#Uv9V&*8h)ENevfc?&f3&SNvz&'llfglXO6Wkdr~v_xwudI4E8q6N %PDF-1.6 % ASC 842 Balance Sheet Changes: A Quick Reference, Visual Lease Reporting Features: ASC 842 Journal Entries. As of Jan. 1, 2022, the Financial Accounting Standards Board (FASB) lease accounting standard, Accounting Standards Codification (ASC) 842, Leases, became effective for many private companies, requiring lessees to recognize most leases on their balance sheets. "Pro forma" financial information can serve useful purposes. This contractual tool may be used two ways; to sell assets, or to purchase assets. For a customer (lessee) the new standard introduces a single accounting treatment, recognition of a right-of-use asset and a lease liability. 165(g)(3), Recent changes to the Sec. To the extent that the "check swapping" between the parties lacks economic substance, such a practice should not alter the accounting for such exchange transactions. In contrast, the most important factor in determining the appropriate federal income tax treatment of a tenant improvement allowance generally is the tax ownership of the resulting leasehold improvements, determined under a benefits-and-burdens-of-ownership analysis. endobj The incurred initial direct cost by the lessee, The lease incentives received by the lessee, Six-year rental period without renewal options, $40,000 lease payment required at the end of each year, The right-of-use asset is increased by 9% (the incremental borrowing rate). 70 0 obj 5 For example, a specific fiber or wavelength of light within a fiber-optic cable network, along with the conduit through which that cable passes, the land on which the conduit rests, and a specific component of the telecommunications equipment at each end of the cable necessary to transmit data over the network, would represent specific identifiable assets. The change is made with a Sec. Payments under the lease agreement are treated as the repayment of a loan. 7) Indefeasible Right of Use (IRU) accounting Indefeasible Rights of Use (IRU's) are rights to use cables, fibres or capacity thereon; such rights are typically contractual and may take the form of capacity or service agreements or leases. Read PLR 202133003 [PDF 111 KB] (release date August 20, 2021, and dated February 5, 2021), Read PLR 202132002 [PDF 111 KB] (release date August 13, 2021, and dated February 5, 2021). that conveys the right to control use of an identified asset for a period of time in exchange for consideration. [225 0 R 229 0 R 230 0 R 231 0 R 232 0 R 235 0 R 238 0 R 239 0 R 240 0 R 242 0 R 243 0 R 244 0 R 245 0 R 246 0 R 247 0 R 249 0 R 250 0 R 251 0 R 252 0 R 253 0 R 254 0 R 255 0 R 256 0 R 257 0 R 258 0 R 260 0 R 261 0 R 262 0 R 263 0 R 265 0 R 266 0 R 267 0 R 268 0 R 269 0 R 273 0 R 274 0 R 275 0 R 276 0 R 279 0 R 280 0 R 281 0 R 282 0 R 283 0 R 286 0 R 287 0 R 288 0 R 289 0 R 290 0 R 293 0 R 294 0 R 295 0 R 296 0 R 299 0 R 300 0 R 301 0 R 302 0 R 303 0 R 304 0 R 308 0 R 309 0 R 310 0 R 311 0 R 312 0 R 313 0 R 314 0 R 315 0 R 318 0 R 319 0 R 320 0 R 321 0 R 322 0 R 323 0 R 324 0 R 325 0 R 328 0 R 329 0 R 330 0 R 331 0 R 332 0 R 333 0 R 335 0 R 336 0 R 337 0 R 338 0 R 339 0 R 340 0 R 344 0 R 345 0 R 346 0 R 347 0 R 350 0 R 351 0 R 352 0 R 353 0 R 354 0 R 355 0 R 356 0 R 357 0 R 359 0 R 360 0 R 361 0 R 365 0 R 366 0 R 367 0 R 368 0 R 369 0 R 370 0 R] Most entities are expected to elect to use the package of transition practical expedients, in which case an entitys classification of its existing leases is not reassessed. Accordingly, taxpayers should continue to perform a separate lease characterization analysis for tax purposes. 1 0 obj 467 rental agreements, and lease acquisition costs with a Sec. endobj endstream endobj startxref In addition to helping investors make better decisions, transparency increases confidence in the fairness of the markets. Furthermore, the exchange of a productive asset not held for sale for a similar productive asset also is not viewed as the culmination of the earnings process. The granting of an indefeasible right to use such network capacity is often referred to as an "IRU." 4.2 The grantor may grant the right to use the international Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP. This all changed with the release of the new lease standard, ASC 842, requiring all leases to be reflected on the balance sheet. While I cannot comment on specific transactions, my testimony seeks to provide an overview of the accounting literature that addresses the accounting for exchanges of nonmonetary assets. Otherwise, the transaction must be classified and accounted for as an operating lease. Although service contracts may have attributes similar to those embodied in leases, the accounting results may be dramatically different for service transactions than for leases. <> The benefit of this interpretation could even be more meaningful if proposals to increase the limited rental exception from 10% of the leased space of the property to 50% are enacted. If the lease transfers ownership of the underlying asset, the ROU asset is amortized to the end of the underlying assets useful life. 2019-43. Accordingly, financial accounting and tax accounting treatment may differ. Therefore, the IRU must include the capacity requirements that are not expected to change as well as make provision for scaling. Sales-type leases: In a sales-type lease, which gives rise to manufacturer's profit, the lessor records the fair value of the leased assets as revenue upon inception of the lease. A: While most of the focus of ASC 842 revolves around the fact that lessees are reporting a lease liability representing the future lease payments, many stakeholders have asked, What is an ROU asset, and how is it accounted for? The ROU asset represents the lessees right to control the use of the underlying lease asset for a period of time. Companies that have mischaracterized a lease for income tax purposes may change their methods of accounting using the automatic procedures in Rev. 786 0 obj <> The lessee changes (or plans to change) the fundamental use of the leased asset. 47 . "Pro forma," in this context, generally refers to the presentation of earnings and results of operations on the basis of methodologies other than GAAP. The taxpayer represented that the capacity leased to its TRS under an agreement will be the same type of capacity that is leased to unrelated third parties under the agreements. A lease prepayment, as its name suggests, is a payment given in advance. 1130 0 obj Pursuant to an IRU, an entity purchasing network capacity has the exclusive right to use a specified amount of capacity for a period of time. 1141 0 obj Once the company has determined all the information needed such as the lease payment, lease term, and discount rate, then the liability can be discounted over the lease period using the discount rate. Different factors affect the amount of liability and discount rate. Daily 20-Minute Product Tour at 1:00PM ET. Accordingly, taxpayers following book treatment may be overcapitalizing costs. 01-08, Determining Whether an Arrangement is a Lease, EITF Issue No. 1073 0 obj The taxpayer also represented that the capacity leased to the TRS and to unrelated persons under the agreements is measured within the applicable area, based on the above methodology. costs are not required to be capitalized for tax purposes. Furthermore, in our oversight capacity, the SEC staff will continue to monitor developments in the accounting practices of the telecommunications industry, and provide recommendations for issues that need to be addressed by the accounting standards-setting organizations. Therefore, the sales-type lease accounting model may not be appropriate for more recent capacity contracts. hbbd```b`` qdfkIY0"BA$$0,:&69D*ui R|>d4=`]4!30` k` 1.1 Grant of IRU.Subject to the terms and conditions of this Agreement, McLeodUSA grants IRU Grantee an IRU in certain Fibers in the McLeodUSA Network as specifically described in Exhibit A. Signals of different tenants are not intermingled at any time. Topic 842 is silent regarding how to account for contingently receivable lease incentives that are expected to be received after the lease commencement date (for example, a buildout allowance provided by the lessor after the lessee incurs buildout costs). 47 . The assumption are as follows: Therefore, the journal entry would be as follows: In the end, computing for the lease liability and the right-of-use asset isnt that complicated, but one has to deal with the tricky task of gathering data. endobj 13, and the related interpretations of this standard, a lease of real estate must transfer title in the leased assets to the lessee in order to be classified and accounted for as a sales-type lease by the lessor. Tax Section membership will help you stay up to date and make your practice more efficient. A: After an impairment, the ROU asset reverts to being amortized over the remaining lease term on a straight-line basis. Recording the lease liability on a companys balance sheet requires you to determine the lease term and lease payment. Entities that elect to apply the package of transition practical expedients should initially measure the ROU asset as follows: A: Yes, unlike the old lease guidance for capital leases, Topic 842 does not prohibit this scenario. Writing-Down Allowance on Payment for Indefeasible Right of Use 3 4 Background 4.1 An international telecommunications submarine cable system is often built and owned by a consortium of members (i.e. 1285 0 obj x`LW!1>;@8.7_SyvN/33f8kO9cCWL_M&,|e:PX ~yAx{[oY1. 318 0 obj <> endobj Accounting by the purchaser of network capacity pursuant to an IRU has not raised significant accounting issues. However, the key characteristics of a typical arrangement include: the right to use specified network infrastructure; for a specified term (often the majority of the useful life of the relevant assets);legal title is not transferred; a number of associated service agreements including Operations and Maintenance ("O&M") and co-location agreements. Both letter rulings were issued by the IRS to the taxpayers on the same date (February 5, 2021) and in response to ruling requests submitted on the same date (July 30, 2020). DXH 1H2Mfp00120m y? 7 116 0 obj 467: Sec. The IRU includes a non-exclusive right to use tangible and intangible property in order to use the IRU Fibers, including but not limited to cable sheathing, troughing . Starting in 2019, entities will need to apply IFRS 16 accounting requirements for leases. Starting in 2019, entities will need to apply IFRS 16 accounting requirements for leases. endobj . 00-11, Lessors' Evaluation of Whether Leases of Certain Integral Equipment Meet the Ownership Transfer Requirements of FASB Statement No. Annette B. Smith, CPA, is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington, D.C. For additional information about these items, contact Ms. Smith at 202-414-1048 or annette.smith@pwc.com. A presentation of financial results that is addressed to a limited feature of financial results or that sets forth calculations of financial results on a basis other than GAAP generally will not be deemed to be misleading merely due to its deviation from GAAP if the company in the same public statement discloses in plain English how it has deviated from GAAP and the amounts of each of those deviations. Following the explanation above, heres a right-of-use asset calculation example. Q: What are some other examples of when the ROU asset might be subsequently adjusted? 1183 0 obj The lessor is treated as owning the property and recognizes depreciation expense and rental income over the lease term. Topic 842 introduces a more robust framework to account for lease modifications than prior GAAP. 20-year (most often 20) Indefeasible Right of Use (IRU). A: Yes, unlike the old lease guidance for capital leases, Topic 842 does not prohibit this scenario. 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