2018-06-07T11:34:05.790-04:00 endobj The extended effective date provides additional time for companies to modify agreements to the extent necessary. These letter rulings evidence the IRSs continuing acceptance that when it comes to non-traditional real propertysuch as pipelines, transmission lines, and fiber optic cables, each of which is capable of being used by multiple users concurrentlyexclusivity can be achieved via specified capacity. 3 While the Commission has the statutory authority to set accounting principles, for over 60 years it has looked to the private sector for leadership in establishing and improving accounting standards. Thus, rental income and expense are almost never reported on a straight-line basis as they are for book purposes. ARTICLE I . "Pro forma" financial information can serve useful purposes. In order to conclude that a network capacity swap transaction should appropriately be accounted for as revenue and a capital expenditure at fair value, a company entering into such a transaction would have to reach the conclusion that: 1) the network capacity received in the exchange will not be sold in the same line of business as the network capacity given up in the exchange, 2) the network capacity received in the exchange is a productive asset that is dissimilar to the network capacity given up, and 3) the fair values of the assets exchanged are determinable within reasonable limits. 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. The International Accounting Standards Board (IASB) has published a new Standard IFRS 16 Leases. Topic 842 should not significantly affect the financial accounting for lessors, although some lessors may conclude, while considering the impact of Topic 842, that they were improperly accounting for leases. A: By recognizing operating leases on the balance sheet, an entity will add to the balance sheet a lease liability classified between current and noncurrent, with the corresponding ROU asset classified as a long-term asset. The taxpayer leases systems composed of permanently affixed coaxial and fiber optic cable, and indoor and outdoor distributed antenna systems (DAS) or small cell systems to organizations, including wireless carriers and other telecommunication providers. When the lessee owns the resulting leasehold improvements, the lessee generally recognizes income and has a depreciable interest in the improvements. The lessor is treated as selling the property and recognizes gain equal to the present value of the lease payments less its basis in the leased property and recognizes interest income over the payment term. Public companies may quite appropriately wish to focus investors' attention on critical components of quarterly or annual financial results in order to provide a meaningful comparison to results for the same period of prior years or to emphasize the results of core operations. 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. Multiple fiber optic cables are combined and contained in rigid conduit piping and are typically buried between two and four feet underground, or are permanently attached to above ground structures (e.g., utility poles). The change raises different questions such as the amount to be recorded as a lease liability and lease asset. 1183 0 obj Thus, differences in the treatment of leases for financial accounting and income tax accounting remain, and implementing Topic 842 may highlight improper historical tax accounting methods. endobj Nonetheless, the Commission is concerned that "pro forma" financial information, under certain circumstances, can mislead investors if it obscures GAAP results. Sales-type lease accounting reflects in the financial statements of the lessor a sale or financing when substantially all of the benefits and risks incident to the ownership of the leased property have been transferred to the lessee. A single strand of fiber has two glass components the core and the cladding, which together are about as thin as a typical human hair. [Emphasis added]. 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. The lessor is treated as owning the property and recognizes depreciation expense and rental income over the lease term. Q: How is the ROU asset subsequently measured? Lease characterization: Generally, the tax characterization of a lease does not follow its book characterization. Therefore, it is critical that all public companies provide an understandable, comprehensive and reliable portrayal of their financial condition and performance. Some companies might have concerns about a perception of additional leverage with ROU assets and operating lease liabilities now on the balance sheet. Starting in 2019, entities will need to apply IFRS 16 accounting requirements for leases. Statements about a company's financial results that are literally true nonetheless may be misleading if they omit material information. endobj The letter ruling included a taxpayers representation that these assets are real property for purposes of the REIT rules and the following description: A fiber optic cable is composed of ultra-thin strands of glass surrounded by layers of insulating materials, including cladding (together, strands). Accordingly, taxpayers following book treatment may be overcapitalizing costs. Topic 842 introduces a more robust framework to account for lease modifications than prior GAAP. 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 . In addition to different accounting treatment, state property and transactional tax implications may be different. <> This interpretation enables a REIT to utilize its TRS for potential arrangements with customers that may not clearly meet the exclusivity requirement. Here are some examples of when a lessee should consider whether an impairment triggering event has occurred: Q: Will adopting Topic 842 change working capital? A: Besides applying the subsequent measurement guidance previously described and evaluating the asset for potential impairment in accordance with Topic 360, entities need to consider the impact to the ROU asset when the following events or conditions take place: Q: What are some examples of circumstances that might necessitate an impairment evaluation under Topic 360? Operating lease accounting is similar to service contract accounting. Daily 20-Minute Product Tour at 1:00PM ET. <> The change is made with a Sec. The right-of-use asset is initially measured at the amount of the lease liability plus any initial direct costs incurred by the lessee. A: After an impairment, the ROU asset reverts to being amortized over the remaining lease term on a straight-line basis. If the Sale/Lease Restriction applies, the recipient must either request a project-specific waiver or comply with the terms of one of NTIA's partial Companies that have mischaracterized a lease for income tax purposes may change their methods of accounting using the automatic procedures in Rev. The annual maintenance charge is the same per mile regardless of whether the lease is for 1 or 10 or 100 strands on the same route. A tax accounting method change may provide more appropriate or beneficial tax treatment. That is, the ROU asset is, in many cases, subsequently measured based on the recalculated lease liability balance, adjusted for the effect of differences between lease payments and straight-line lease cost. accounting procedures generally used by GCCIA and which it utilizes in billing third parties for reimbursable projects which costs shall include, without limitation, the following: (i) internal . . However, Regs. An entity purchasing capacity would typically record the amount paid for the capacity as an asset,2 and amortize that asset by charges against income over the period of benefit, which would normally be the term of the capacity agreement. 1073 0 obj It also helps to have reliable lease accounting software for proper accounting and record entry of right-of-use assets. 1108 0 obj 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. If triggering events are present, the lessee performs a two-step impairment test, as follows: The lessee has completely abandoned the leased asset by permanently ceasing its use with no right or intent to sublease the asset. The differences in lease classification are outlined in the following table: Q: What does an ROU asset mean in accounting? 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. Similarly, most operating leases under existing GAAP will remain operating. KPMG International Limited is a private English company limited by guarantee and does not provide services to clients. 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). "Pro forma," in this context, generally refers to the presentation of earnings and results of operations on the basis of methodologies other than GAAP. 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. For example, an exchange of an asset held for sale in the ordinary course of business (such as inventory) for an asset to be sold in the same line of business. A right to use an asset is a separate lease component if the . Costs to dismantle/remove/restore the underlying asset (an estimate) The lessee subleases (or decides to sublease) the leased asset. Get the latest KPMG thought leadership directly to your individual personalized dashboard, Do Not Sell/Share My Personal Information, PLRs: IRS acceptance of non-traditional real property (such as fiber optic cable) for REIT income tests. For the provider of the capacity, the fundamental accounting issue related to an IRU is when to recognize revenue. that conveys the right to control use of an identified asset for a period of time in exchange for consideration. \g)4+Hl3hc3|Xdr2_ot[*32eq~`D55 N When cash consideration is exchanged between the parties to a transaction concurrently with an asset exchange, questions may arise as to the substance or business purpose of the transaction structure, and whether that structure has an economic purpose or is designed solely to remove the transaction from the scope of the accounting literature governing nonmonetary asset exchanges. 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. costs are not required to be capitalized for tax purposes. How to calculate the right-of-use asset under ASC 842 Under ASC 842, initial operating and finance lease ROU assets are calculated using the exact same method. The customer pays up front for the IRU and annually for maintenance. [115 0 R 119 0 R 120 0 R 121 0 R 122 0 R 125 0 R 128 0 R 131 0 R 132 0 R 133 0 R 134 0 R 135 0 R 136 0 R 137 0 R 138 0 R 139 0 R 140 0 R 141 0 R 142 0 R 144 0 R 145 0 R 146 0 R] endstream )C7Me~?f~( %PDF-1.6 % Accordingly, taxpayers following book treatment may be overcapitalizing costs. This contractual tool may be used two ways; to sell assets, or to purchase assets. The minimum lease payments are recorded as rental revenue by the lessor over the lease term, typically on a straight-line basis. 70 0 obj 13 See Financial Reporting Release No. x][s8~OU1C\InMdNL|vf-S%xq! 47 0 obj endobj A: Applying the impairment model in Topic 360 can be a complex assessment for lessees. Equipment leases need not transfer title in the leased assets to the lessor in order to be classified and accounted for as sales-type leases. 1285 0 obj <>/MediaBox[0 0 612 792]/Parent 2 0 R/Resources<>/Font<>/ProcSet[/PDF/Text/ImageB/ImageC/ImageI]>>/StructParents 8/Tabs/S/Type/Page>> endobj 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. Topic 842 does not affect how leases are treated for federal income tax purposes. This site uses cookies to store information on your computer. 373 0 obj In contrast, for tax purposes leases are characterized based on all the facts and circumstances existing at the time an agreement is executed. 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). ASC 842 Balance Sheet Changes: A Quick Reference, Visual Lease Reporting Features: ASC 842 Journal Entries. Signals of different tenants are not intermingled at any time. 378 0 obj <>stream . The interest cost of $55,056 will be taken to the statement of profit or loss as a finance cost. The objective of this Standard is to prescribe the accounting treatment for property, plant and equipment so that users of the financial statements can discern information about an entity's investment in its property, plant and equipment and the changes in such . An IRU is an agreement by which a telco provides another company (e.g., an Internet service pro-vider (ISP)) with the right to use its telecom network to transmit voice and data traffic. 89 0 obj <>/Filter/FlateDecode/ID[<755106BB418624B9F57BBC2462B1BBAA><5B6CED9D76D7F9449BAA8BF1025EE0F9>]/Index[65 42]/Info 64 0 R/Length 113/Prev 185329/Root 66 0 R/Size 107/Type/XRef/W[1 3 1]>>stream 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. An area is comprised of a geographic footprint that allows an assigned team of field employees to focus on local customer and service needs. With respect to the lease to the TRS, section 856(d)(8)(A) (or the limited rental exception) provides that amounts paid to a REIT by its TRS are not excluded from rents from real property by reason of the TRS being related to the REIT if, with respect to any property, at least 90% of the leased space of the property is rented to persons other than the REITs TRSs and other than related persons. The primary private sector standards-setter is the Financial Accounting Standards Board ("FASB"). 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. endobj Many of the accounting issues surrounding the accounting for telecommunications capacity contracts are complex, and I have provided only a brief summary of some of the more significant issues. With appropriate disclosure, accurate interpretations and summaries of GAAP financial statements benefit investors. That determination can be quite complex but can be boiled down to two basic questions: Is the IRU a lease or is it a service contract? In addition to helping investors make better decisions, transparency increases confidence in the fairness of the markets. Direct costs incurred by the lessee. If the lease transfers ownership of the underlying asset, the ROU asset is amortized to the end of the underlying assets useful life. %%EOF Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP. 657980 Marrying ESG initiatives to business tax planning, Early access to wages may require new employment tax analyses, Determining gross receipts under Sec. A: The answer depends on whether the lease is classified as a finance lease or an operating lease, as follows: Q: How is the ROU asset of an operating lease subsequently measured after an impairment? 786 0 obj The Sale/Lease Restriction may apply to an indefeasible right-of-use (IRU) arrangement that a recipient or subrecipient wishes to convey to another party for the use of BTOP-funded facilities. A: Besides applying the subsequent measurement guidance previously described and evaluating the asset for potential impairment in accordance with Topic 360, entities need to consider the impact to the ROU asset when the following events or conditions take place: A modification is made that does not grant the lessee an additional ROU asset at a market rate, including a partial termination of the lease. In a sale/financing arrangement, the lessee is the tax owner of the leased property and depreciates the property under Secs. Similarly, a payment made to the current tenant as an incentive to end the present lease contract would likely be classified as an initial direct cost because this cost was incurred since the new lease contract was signed. This article discusses the history of the deduction of business meal expenses and the new rules under the TCJA and the regulations and provides a framework for documenting and substantiating the deduction. 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 65 0 obj <> endobj However, several mitigating factors exist, including these1: 1 Accounting Standards Update 2016-02, Leases (Topic 842) Section C Background Information and Basis for Conclusions, paragraph BC14, FASB, https://fasb.org/jsp/FASB/Page/SectionPage&cid=1176156316498, 10 observations for private companies lease accounting, Accounting for leases: ASC 842 deferred but not forgotten. endobj The Tenant is required to pay for the contracted usage, regardless of the Tenants actual usage, and Taxpayer ensures that the Tenant has access to its contracted usage during the terms of an Agreement. 12 See Regulation S-K, 17 CFR, Item 303. Operating leases result in straight-line expense, and finance leases result in a front-loaded expense pattern. endobj Leases subject to Sec. Second, a presentation of financial results that is addressed to a limited feature of a company's overall financial results (for example, earnings before interest, taxes, depreciation, and amortization), or that sets forth calculations of financial results on a basis other than GAAP, raises particular concerns. 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. There is no universally-accepted definition of an IRU. 467 generally applies to lessors and lessees when (1) rental agreements are for the use of tangible property; (2) total rent under the agreement exceeds $250,000; and (3) the rental agreement provides for increasing or decreasing rent, or prepaid or deferred rent, subject to limited exceptions (such as a three-month rent holiday at the beginning of a lease term). To the extent that a network capacity contract conveys to the purchaser the right to use specific identifiable assets5 for a period of time, providers of this capacity have concluded that such a contract meets the definition of a lease. 4.2 The grantor may grant the right to use the international For more detail about the structure of the KPMG global organization please visit https://kpmg.com/governance. <> Accordingly, financial accounting and tax accounting treatment may differ. FASB Accounting Standards Codification Topic 842, Leases, significantly affects financial statement accounting for lessees, eliminating the traditional concept of an operating lease and requiring virtually all leases to be presented on the balance sheet. A right-of-use asset consists of 4 elements: The initial measurement of the lease liability (more on this in a moment) Lease payments already made, net of lease incentives received. The lessor may depreciate the assets under Secs. [372 0 R 376 0 R 377 0 R 378 0 R 379 0 R 382 0 R 385 0 R 390 0 R 391 0 R 392 0 R 393 0 R 394 0 R 396 0 R 397 0 R 398 0 R 399 0 R 400 0 R 401 0 R 402 0 R 403 0 R 405 0 R 406 0 R 407 0 R 408 0 R 409 0 R 410 0 R 411 0 R 412 0 R 413 0 R 414 0 R 415 0 R 417 0 R 418 0 R 419 0 R 420 0 R 421 0 R 422 0 R 423 0 R 424 0 R 425 0 R 426 0 R 427 0 R 428 0 R 429 0 R 430 0 R 431 0 R 432 0 R 434 0 R 435 0 R 437 0 R 438 0 R 439 0 R 440 0 R 441 0 R 442 0 R 443 0 R 444 0 R 445 0 R 446 0 R 447 0 R 448 0 R 449 0 R 450 0 R 451 0 R 452 0 R 453 0 R 454 0 R 457 0 R 458 0 R 460 0 R 461 0 R 462 0 R 463 0 R 464 0 R 465 0 R 467 0 R 468 0 R 469 0 R 470 0 R 471 0 R 472 0 R 473 0 R 474 0 R 475 0 R 477 0 R 478 0 R 479 0 R 480 0 R 481 0 R 482 0 R 483 0 R 487 0 R 488 0 R 489 0 R 490 0 R 492 0 R 493 0 R 494 0 R 495 0 R 496 0 R 497 0 R 498 0 R 499 0 R 500 0 R 501 0 R 502 0 R 503 0 R 504 0 R 505 0 R 506 0 R 508 0 R 509 0 R 510 0 R 511 0 R 512 0 R 513 0 R 514 0 R 515 0 R 517 0 R 518 0 R 519 0 R 520 0 R 521 0 R 522 0 R 524 0 R 525 0 R 526 0 R 527 0 R 528 0 R 529 0 R 530 0 R 531 0 R 532 0 R 533 0 R 534 0 R 535 0 R 537 0 R 538 0 R 539 0 R 540 0 R 541 0 R 543 0 R 544 0 R 545 0 R 546 0 R 547 0 R] Consequently, lease incentives that were recognized upon initial measurement of the ROU asset subsequently are adjusted through the adjustment to the ROU asset. 467 rental agreements, and lease acquisition costs with a Sec. These types of nonmonetary exchange transactions are required to be accounted for based upon the recorded amount, or book value, of the asset relinquished. In other words, the accounting rules for nonmonetary asset exchanges should be followed. In other words, the purchaser of the IRU is permitted to use it without any interference by anyone other than for required maintenance. The liability is equal to the present value of future lease payments. <> 2016-02. , 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). 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. THIS IRU AGREEMENT . However, several mitigating factors exist, including these. You must also know the rate to be used in discounting the lease liability. endobj 29, Accounting for Nonmonetary Transactions, provides relevant guidance on the accounting for these types of transactions. Accounting by the purchaser of network capacity pursuant to an IRU has not raised significant accounting issues. 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). endobj This article discusses some procedural and administrative quirks that have emerged with the new tax legislative, regulatory, and procedural guidance related to COVID-19. Beyond the questions and objectives of IRUs is the treatment of network expansion in the form of . 1119 0 obj For capacity contracts that meet the definition of a lease, the next significant accounting consideration is the determination of the appropriate lease classification. endobj [IFRS 16:24] If the information in financial reports is transparent, then investors and other users of the information are less likely to be surprised by unknown transactions or events. New financial accounting model for lessees and lessors. *Private letter rulings are taxpayer-specific rulings furnished by the IRS Office of Chief Counsel in response to requests made bytaxpayers and can only be relied upon by the taxpayer to whom issued.
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