The Securities and Exchange Commission is getting questions about some follow-on effects associated with new lease accounting rules, like presentation in the contractual obligations table and the make-up of certain non-GAAP numbers.
SEC staff members met with the Center for Audit Quality’s SEC Regulations Committee to acknowledge concerns and answer questions, as best they can so far. The staff said they are considering how companies should comply with requirements under Regulation S-K regarding disclosing contractual obligations now that Accounting Standards Codification Topic 842 brings lease-related assets and liabilities into financial statements.
Staff members shared more pointed views, however, on how not to calculate EBITDA—the infamous non-GAAP measure that depicts earnings before interest, taxes, depreciation and amortization—now that ASC 842 has changed the depreciation figure appearing in financial statements.
With respect to the contractual obligations table, companies are beginning to recognize those disclosures will differ more from their lease maturity disclosures under ASC 842 than they did under historic accounting rules, says Kendra Decker, partner-in-charge of SEC Regulatory Matters at Grant Thornton and a member of the SEC Regulations Committee. They’re wondering if the SEC will have concerns about this, she said.
The contractual obligations table is a disclosure required under Regulation S-K that enables investors to see a company’s long-term debt obligations, capital leases, operating leases, purchase obligations, and other long-term liabilities. The cash flows associated with each category are organized by time horizon, so investors can see, for example, payments due in less than one year, in one to three years, and so on.
SEC staff views on EBITDA under ASC 842 and IFRS 16
“The staff would continue to object to a non-GAAP measure presented by a U.S. GAAP registrant that adjusts EBITDA to add back any operating lease expense since it is not recorded as ‘depreciation’ or interest under ASC 842,” the CAQ’s meeting summary says. “Likewise, the SEC staff would view a measure presented by an IFRS registrant that adjusts EBITDA to deduct interest and depreciation solely related to leases as an individually tailored accounting principle.”
“The staff would not object to both U.S. GAAP and IFRS registrants separately identifying the differences (e.g., a U.S. GAAP registrant may separately disclose lease expense recognized during a period attributable to operating leases consistent with its ASC 842 disclosures or an IFRS registrant may separately disclose the amount of interest anddepreciation expenses under IFRS 16) in their filings.
ASC 842 also requires companies to provide an analysis of lease maturities to show the undiscounted cash flows on an annual basis for at least the first five years, separating operating leases and finance leases. Prior accounting standards didn’t provide explicit guidance about how to calculate the cash flows, says Decker. “There’s much more specificity in ASC 842 on how that has to be done, which will make it diverge a little from pure cash outflow,” she says.
Companies want to give investors consistent information, says Decker, so the potential for differences is a concern. “Historically, there was not a discrepancy,” she said.
That prompted the SEC Regulations Committee to ask the staff whether they might have raised an eyebrow over differences in how cash flows are expressed in the two different tables. “The staff is aware of the issue, and they are thinking about it, but they are not ready to give a position,” Decker said.
Rich Davisson, a partner at audit firm RSM, says the key difference between the disclosures under old compared with new standards is whether they reflect an implied interest rate. “The question to the SEC is do you want to see the gross amount or the net amount of interest in disclosures,” he says. “The contractual obligations table may not be comparative across companies. Or people may report differently, so there may not be consistency from year to year, or company to company. The SEC agreed there may be differences out there, but they’re not sure. They are looking at it.”
The contractual obligations table is required only in year-end reports, and companies are nearing the end of their second quarter observing the new lease accounting rules, so the issue will be front-and-center in year-end reporting. In the meantime, if companies have concerns about their particular circumstances, they are advised to contact the SEC directly, says Davisson.
As for the EBITDA question, the SEC staff discussed with the Regulations Committee how the EBITDA figure will change under ASC 842 and how it might compare with companies reporting under International Financial Reporting Standards, said Decker.
Under IFRS 16, companies are also bringing leases on to corporate balance sheets, but with different effects on the income statement. GAAP retains a two-lease model, with operating leases treated like rental agreements and finance leases treated like capital acquisitions. IFRS requires leases to be treated only like financed acquisitions.
The result is that many contracts with the same economic characteristics will produce a depreciation expense for IFRS-reporting companies but a lease operating expense for GAAP-reporting companies. That would produce big differences in the comparability of the popular EBITDA non-GAAP figure.
“EBITDA will look better for an IFRS company,” says Decker. The SEC Regulations Committee and the SEC staff pondered whether that might prompt some companies reporting under GAAP to recast their EBITDA as if more of their leases were reported as finance-type leases, to make their EBITDA figures more comparable with IFRS-reporting companies, she said.
Don’t do it, says SEC staff, which has been carrying a torch for compliance non-GAAP reporting for a few years now. Instead, just disclose it separately.
Making a single change to a GAAP standard to present a non-GAAP number would be considered an “individually tailored accounting principle” by the SEC, says Heather Winiarski, a shareholder at Mayer Hoffman McCann. Adjusting a figure for part, but not all, of a GAAP concept is considered a violation of the SEC’s rules on proper uses of non-GAAP measures, she says.
“It’s an interesting nuance,” says Davisson. “The SEC is signaling don’t try to add back rent to make EBITDA more comparable.”