By: John Klee, Senior Advisor, TPI
* TPI is not an accounting firm and does not give accounting advice or guidance. Clients and service providers need to engage their own accounting groups for formal opinions; however, TPI is familiar with the RFP formation and industry practices that should be incorporated into the client decision process.
There are several issues that need to be considered around start-up & transition and asset ownership including:
- Asset ownership: Asset valuations, Lease Types
- Start-up, Transition, Transformation and One-Time Charges: Expensed vs Capitalization
- Restructuring costs
ASSETS - Some deals may include the purchase or transition of assets from a client to the service provider. While this is less common than in prior years, it still happens. What are the issues that need addressed?
- Ownership – who actually owns the asset?
- Ownership is often based on control. Remember the old saying, “Possession is nine-tenths of the law”? If you have exclusive rights to possess and control the property or consume all or most of its output, then you likely “own” the asset from an accounting interpretation. Whether you have title or not will determine if you have the asset on your books as PP&E (Property, Plant & Equipment) or a lease.
- Valuation – how do both parties value the transaction?
- It is always easier for the entity transferring the asset (normally client); they use book value as the basis and assign the actual “price” based on the contract details. The receiving entity will look for FMV (Fair Market Value) often using outside companies that provide this service.
- Leases – Operating versus Capital and Embedded leases.
- Leases can be determined to be operating or capital. Without getting into the detail, the benefit is that operating leases do not show up on a company’s balance sheet. However, the entities that issue accounting guidance in the US and International markets are working together in redefining their leasing guidance and eliminating the operating lease.
UPFRONT COSTS – There are a variety of costs incurred before actual services begin or in the initial stages of delivery. Most of these costs are expensed by the client. Service providers need to follow various revenue recognition guidelines in order to recognize the revenue when actually earned (and not at risk) versus when billed or cash is collected.
- Client costs – when to recognize
- As stated, most transition and transformation costs are expensed by clients. This includes setting up any Governance Offices related to the new contract. This does not mean that any actual capital expenditures (PP&E) made for the Governance Office are not capitalized.
- Costs that may be capitalized are those related to the development or modification of internal use software. This can be done as a project, as part of a service contract’s scope of work or within the transition/transformation work. The general rule is that the actual costs of development/modification of the SW created or modified for internal use can be capitalized.
As always, client and service provider accounting experts need to be engaged, but we can offer direction to the teams on issues that must be addressed.
Thought for the day, “Accounting rules are leaning towards full-disclosure, which is giving owners and investors as much information as possible. Off-Balance Sheet financing, major accounting scandals and other issues have driven regulatory and accounting guidance to tighten rules and attempt to increase transparency in financial statements. This is good for everyone, but the person making all the journal entries.”
More to come…
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