JAK + CO.

Certified Public Accountants

Call Our Minnesota CPA Firm: 651.641.1099

Capital Lease or Operating Lease? 4 Questions to Ask

By

Stephanie LoilandBy Stephanie Loiland, CPA

Many companies choose to lease assets for a period of time instead of buying them outright. If you’re in this situation, it’s important to know whether you’re dealing with a capital lease or an operating lease. That’s because the type of lease will affect how you record it—and the payments you make to it—in your books.

A few additional differences between capital and operating leases to consider: Capital leases affect your balance sheet, which means they can also impact your covenants and ratio calculations. Also, capital leases allow the leased asset to be capitalized. If an asset is capitalized, it could possibly qualify for an accelerated depreciation option such as bonus depreciation or Section 179, providing you with a larger deduction in the year you sign the lease. Operating leases, on the other hand, require less administrative time to account for them and do not affect the balance sheet.

Not sure if a lease is capital or operating? Here are four questions that can help you determine its classification. If you answer “yes” to any of the questions, the lease is a capital lease. If you answer “no,” it’s an operating lease.

#1 – Is there a transfer of ownership?

If the lease states that your company retains ownership of the leased asset at the end of the lease, it’s a capital lease. In this case, the lease acts as a loan for you to purchase the leased asset.

#2 – Is there a bargain purchase option?

Many leases contain an option to buy out the leased asset at the end of the lease. If this option is less than the expected fair market value of the asset at the end of the lease, it represents a bargain purchase option. Leases that include a bargain purchase option are capital leases. The most common example of this type of lease is a $1 ending purchase option.

#3 – Does the lease period equal or exceed 75 percent of the asset’s useful life?

If the lease in question does not contain #1 and #2 above, the length of the lease is compared to the economic life of the leased asset. If the lease period is equal to or exceeds 75 percent of the leased asset’s useful life, it’s a capital lease. Your company’s capitalization policy should provide guidance on the length of life used for the type of asset being leased.

Minimum Lease Payment

#4 – Does the present value of the minimum lease payments exceed 90 percent of the asset’s fair market value?

If the lease does not contain any of the above features, the present value of the minimum lease payments should be compared to the fair market value of the leased asset. The present value of the lease payments can be calculated by inputting the total amount of lease payments to be paid over the life of the lease into a present value calculator. The fair market value of the leased asset is equal to its cash price. If the calculated present value of the lease payments is equal to or exceeds 90 percent of the asset’s fair market value, the lease is a capital lease.

What to know about recording the lease and lease payments

Operating leases are simple to record. The payments are recorded each month as an expense in a lease expense account; no asset or liability is recognized on the balance sheet.

Capital leases, however, require the value of the leased asset to be capitalized and recorded as a fixed asset on the balance sheet. This fixed asset is depreciated over time like any other fixed asset purchase. The related lease obligation is also recorded as a liability on the balance sheet and payments are applied to the obligation with a portion segregated for interest expense.

Lease classifications will change in the coming year—stay tuned!

A new lease standard effective for years beginning after December 15, 2019, will change the classification of leases. As this effective date approaches, the small business CPA firm of JAK, will provide more information on what you can expect. In the meantime, if you have questions about lease classifications or the new standard mentioned here, please don’t hesitate to call.

Top 5 Ways the New Revenue Recognition Standard Will Impact the Construction Industry

By

Kyla Hansen

By Kyla Hansen, CPA

There’s been a lot of talk about the new revenue recognition standard and the effect it could have on the construction industry. Although the standard, known as Accounting Standards Update (ASU) 2014-09, was first issued by the Financial Accounting Standards Board (FASB) in 2014, it goes into effect for privately held companies—for periods beginning after December 15, 2018, to be exact.

This means that if you are a privately held company with a December 31 year-end, this change will impact your 2019 financial statements. The good news is percentage of completion isn’t going away! However, there are several nuances that will need to be considered.

Here are five changes you should be aware of:

1 – Combination and segregation of jobs will be based upon performance obligations

  • Contracts will now be defined and tracked by performance obligations—i.e., the underlying deliverables. This concept may cause certain contracts that have one shared performance obligation to be combined, even if they were previously considered separate. Additionally, this concept may also cause a contract to be segregated into separate pieces based on the number of performance obligations it includes. Going forward, each contract will need to be closely evaluated to identify performance obligations.
  • Change orders will also be impacted by this concept. Some change orders may create a new performance obligation, resulting in an additional job that would have to be tracked separately on the contract schedule, while others may not.   Construction CPA Minneapolis- Front-Loaded Costs

2 – Front-loaded costs will no longer recognize early profit

  • Significant costs incurred after a contract is obtained but before goods or services are transferred will need to be capitalized and amortized over the life of the contract. These costs include items such as mobilization and bond costs, and do not include bid, proposal, and selling or marketing expenses. This treatment applies only if all of the following criteria are met:
  • The cost directly relates to a specific contract
  • The cost generates or enhances resources that will be used in satisfying the performance obligation(s) in the future
  • The cost is expected to be recovered (directly or indirectly)

3 – The transaction price might not be the stated value on the contract

 When determining a transaction price, the new standards leave room for more judgment regarding the circumstances surrounding a contract and also allow for greater reliance on historical experiences. For example, if the contract is for time and material, the transaction price will represent the amount you anticipate the job to require. In addition, contracts will need to be evaluated if there are variable items such as contingent income or damage provisions. The new standards allow for several methods to evaluate the contract value. We expect the most commonly used methods to be the following:

  • Most likely value method: Used when there are only two possible values. You select the value that is most likely to occur.
  • Expected value method: Used when there is a range of possible amounts; each scenario is weighted based upon probability of occurrence. This determines the transaction price that you will use on your job schedule as the contract amount.

4 – Anticipate changes to your financial statements

  • Your balance sheets will include new items and names.
  • Contract assets: This will include costs in excess of billings, unbilled receivables, contract adjustments for variable consideration, and capitalization of costs to fulfill a contract such as mobilization and bonds. As I mentioned previously, these costs will be amortized over the life of the contract.
  • Contract liabilities: This will include billings in excess of costs, accrued warranty, refundable consideration, and customer deposits.
  • Retained earnings adjustment: If you adopt the new standard ahead of time, you will need to adjust your retained earnings to account for open contracts at the end of 2018 or restate your 2017 amounts in order to comply.
  • Additional footnote disclosures: There is a considerable amount of additional footnote disclosures that explain your policies and methods for determining contract prices and related revenue recognition.

5 – Understand the impact on your ratios

In light of the new standard, you may need to discuss modifying metrics used to determine items such as loan covenants or bonding capacity. For example, a lending agent might not give credit for a variable consideration contract asset.

Don’t get caught off guard.

The new revenue recognition standard will go into effect in less than two months, which means now is the time to get ready for the changes I’ve listed here—and the others I haven’t. Don’t forget: Team at JAK can help you pinpoint the ways your business will be affected, so you can prepare with efficiency. If you have questions, please please contact our St. Paul office today.

3 Simple Ways to Make Life Easier During Your Next Audit

By

By Nate Graf, CPA

 “I can’t wait for our audit!”—said no one ever. Yes, as auditors, we get it: an independent audit of your organization’s financial statements is probably not an event you anticipate with glee. But with a little preparation, the audit process can be—dare we say—downright painless. Here are three simple things you can do to make life easier during your next audit:

  1. Establish an organized filing system.

While an auditor won’t look at every transaction, they could look at any transaction. Preparing for your audit begins with keeping organized accounting records throughout the year. If your accounting records are unorganized (e.g., stashed in a box) or impossible to find, it won’t be a quick and easy process. At a minimum, neatly file away documentation of expenses, revenues, and significant agreements such as leases and loans. Also, be sure to document any internal approval processes you have in place so the auditors can verify the transaction was approved. For example: a manager initials all the invoices they approve.

  1. Reconcile accounts soon after year-end.

When it comes to reconciling accounts, it pays to be proactive. Preparing detailed schedules of all balance sheet accounts will help you catch potential errors. You can also give these schedules to the auditors to support your account balances. If you’re not sure about an account, or if you’re unable to reconcile it, ask your auditor for guidance before they show up.

  1. Complete your auditor’s checklist.

Prior to your audit (usually around year-end), your auditor will provide a detailed list of exactly what he or she needs to complete it. Although it may be tempting to set it and forget it, don’t. Regardless of how organized your filing system or accounts are, you will need time to pull together schedules and find the necessary source documents. Completing as much of the auditor’s checklist as you can—as soon as possible—can help to prevent a stressful rush later.

You can never be too prepared.

Checking these three practices off of your to-do list is a great way to prepare for your next audit—if you don’t leave them until the last minute, that is. The more prepared you are, the more efficient your auditors will be, allowing your audit to be as quick and painless as possible. If you have questions about this topic or are feeling overwhelmed at the thought of preparing for your auditor, please don’t hesitate to give us a call.

5 Signs It’s Time to Break Up With Your Bank

By

Kyla Hansen

By Kyla Hansen, CPA 

Your bank should be an asset, never a hindrance. If yours is holding you back, don’t feel trapped—consider shopping around. Here are five signs it could be time to say goodbye.

  1. Your loan covenants are too restrictive.

When a business fails its covenant, nine out of 10 times the bank will waive it with little difficulty, but this can create some level of difficulty on your end. Covenants are very common and necessary in many situations; however, if a bank isn’t familiar with a client’s situation, it may inadvertently set covenants higher than they need to be.  If you’re having to repeatedly request waiver letters, it may be time for a switch.

  1. Your banker is consistently MIA.

Good communication is critical to any relationship, and especially to the one between you and your bank. At a minimum, your banker should contact you quarterly to see how your year is going. Of course, communication is a two-way street, but if your banker rarely checks in or doesn’t return your calls, ask yourself: Could I get better service elsewhere?

  1. You don’t have a relationship manager.

On a similar note, dealing with different banker every time you interact with your bank is not ideal. Working with a banker who is comfortable and familiar with your business can prevent headaches, especially if your business is unique or seasonal.

  1. You’ve outgrown it.

Federal lending restrictions and limitations are generally based on a bank’s size. If your needs have exceeded your bank’s lending capabilities, it’s possible you could benefit from a larger establishment. Keep in mind that some banks will augment their lending power by offering an SBA loan. This approach gets part of the loan off of the bank’s coverage, but it can create additional fees and expenses for you. In some situations, however, an SBA loan will be the best fit for your business needs. If your bank suggests an SBA loan, make sure it’s the best option for you.

  1. They are behind the times.

Your bank should be able to support you with resources such as remote deposit, company credit cards and even fraud protection features such as Positive Pay. Having access to these not only creates efficiencies but also provides additional controls. If your bank is lacking in this area, you may be better served elsewhere.

Do your research before breaking up.

Moving your business to another bank should never be done on a whim. Think about the pros and cons. For instance, Bank ABC might have a higher lending capacity, but will moving expose you to pre-payment penalties at Bank XYZ?

Also, if you’re not happy with your bank, say so. Many business owners don’t realize it, but loan covenants are not set in stone—they can be negotiated. The banking industry is highly competitive, and many banks are willing to work with you, whether by offering a lower rate or additional services, to keep your business.

Confer with your accountant.

 Should you stay or should you go? Talk to your accountant before you make the call. He or she can help you identify pros and cons of switching and compare rates of other establishments. At JAK, we’ve helped several clients determine whether or not to end a banking relationship by running numbers and sharing our perspective.

When it comes to business banking, it’s important to know your options. And to make sure they are truly working for you. If you do need to make a change, know that we have strong relationships with many bankers, and can easily recommend a banker who we feel is a good match for you.

Are You Doing Enough to Prevent Fraud?

By

By Joy McAdoo, CPA

 “It could never happen to us.” When it comes to fraud, these are all too often the famous last words of small business owners. But fraud can happen to or within any organization. And any instance of fraud has the potential to be devastating. Thankfully, there are some fairly straightforward and inexpensive steps you can take to prevent it. 

Here are seven basic fraud prevention measures (i.e., controls) every business owner should follow.

  1. Segregate duties as much as possible.

Segregating duties involves making sure one person doesn’t have sole authority over any one process, which can be difficult when your employees wear several hats. But ignoring this control could be a recipe for disaster. For instance, someone who has the authority to prepare and authorize transactions should not be in charge of reconciling those transactions. Likewise, the person who signs a check should not be the same person who prepares it. Being aware of areas where duties may not be as segregated as they should be—or identifying new opportunities for segregation—is a critical step in keeping fraud at bay.

  1. Pay attention to cash processing activities.

Cash processing is often where the biggest risk for fraud lies in small businesses. But you can mitigate it by monitoring these activities. Best practices include regularly reviewing online banking activity, and having physical bank statements mailed directly to you, the business owner, rather than to an employee at your business. In addition, avoid writing checks out to ‘cash’ and consider requiring dual signatures on checks or wire transfers over a certain dollar value.

  1. Be smart about email fraud schemes.

Email fraud schemes are becoming more and more rampant, and criminals are growing bolder and bolder. While email-filtering software is designed to catch fraudulent emails, many fall through the cracks. For these reasons, it pays to be vigilant. Always be suspicious about any email you receive asking for banking information or money, and take appropriate measures to verify the authenticity of the sender. It’s also important to keep your computer security and firewall updated, and to only download files from known and reputable sources.

  1. Take advantage of Positive Pay.

Most banks offer a tool called Positive Pay that matches checks written by a business against those the business has previously authorized. It can detect fraudulent checks and prevent them from being paid. If you’re not taking advantage of this service, talk to your banker and set it up as soon as you can. It’s an easy way to guard against fraud—before it touches your bottom line.

  1. Implement sound hiring and training practices.

Preventing fraud starts with hiring honest people. Always insist on a background check, and be sure to call references of potential hires. Once your carefully screened employees are on the job, make sure they are trained in fraud prevention to allow them to serve as the eyes and ears of your company.

  1. Send a strong message: Fraud will not be tolerated.

 The fear of getting caught can be a significant deterrent—don’t be afraid to let your employees know they’re being watched. And if fraud happens, deal with it appropriately. Everyone should be aware of the consequences.

  1. Resist the temptation to put fraud prevention on the back burner.

Implementing basic fraud prevention measures as soon as possible is an investment in the long-term viability of your business. If you have questions about any of these controls and how they might work for you, don’t hesitate to give us a call.

Our Office

1781 Prior Avenue North
Falcon Heights, MN 55113
Main 651.641.1099
Fax 651.647.1099
www.jakcpa.com

John A. Knutson & Co., PLLP

John A. Knutson & Co., PLLP, (JAK) is a Twin Cities-based accounting firm serving clients throughout Minnesota and beyond. A Team Committed to Quality Beyond Expectations