Course | Intermediate | Capital Finance

This course provides basic information about forms of long-term debt available to hospitals and how much an organization can and should borrow. It also explains the nature of the covenants, or legal obligations, placed on the borrower of he...

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Course | Basic | Capital Finance

This course provides basic information about forms of long-term debt can be restructured, gives examples of how to calculate present value, and provides information on how capital and operating leases work and which criteria credit agencies...

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Q&A | Capital Finance

Ask the Experts: Reagent Agreements

Q&A | Capital Finance

Ask the Experts: Reagent Agreements

How do you record reagent agreements for which the vendor locks in the price on various reagents if the hospital commits to a minimum purchase quantity each year?

How do you record reagent agreements for which the vendor locks in the price on various reagents if the hospital commits to a minimum purchase quantity each year? The vendor also “gives” the hospital the processing instrument/equipment for the reagents. Basically, the vendor builds the cost of the equipment into the minimum purchase quantity.

Facts:

  • The agreement transfers ownership of the instrument/equipment to the hospital once the purchase commitment is fulfilled.
  • Title to the equipment remains with the vendor until the purchase commitment is fulfilled.
  • The term of the purchase agreement is at least 75% of the estimated useful life of the equipment.
  • The instruments and the reagents (consumables) are interdependent and neither has a stand-alone value.
  • At the end of the fixed period, new equipment will be provided with a renewal.
  • Charges for the equipment are not separately stated.

Does this agreement constitute a capital lease where the value of the equipment as well as a related liability should be booked? If so, how do you identify the value of the equipment, as many vendors do not provide the cost of the equipment separately from the cost of the consumable? Or, because there is no resale market value for the equipment and therefore its fair market value is near zero, would this support the argument for incidental treatment of the equipment with the reagent expense recognized as supply expenses as incurred?

Answer: The Financial Accounting Standards Board (FASB) issued its new standard on accounting for leases. Under the new standard, a lessee is required to recognize most leases on its balance sheet, which is a significant change from today’s accounting requirements. The present value analysis becomes critical. Many of our operating leases for lab via reagent rentals will be converting to capital leases.

An entity is required to determine the classification of a lease at lease commencement. The classification criteria under the new standard apply to both lessees and lessors. The evaluation focuses on whether control of the underlying asset is effectively transferred to the lessee (e.g., substantially all of the risks and rewards related to ownership of the underlying asset are transferred to the lessee). Therefore, a lease would be classified as a finance lease—from the standpoint of a lessee—or a sales-type lease—from the standpoint of a lessor—if any of the following criteria are met: 

  •  The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
  •  The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise.
  •  The lease term is for the major part of the remaining economic life of the underlying asset.
  •  The present value of the sum of the lease payments and any residual value guaranteed by the lessee . . . equals or exceeds substantially all of the fair value of the underlying asset.
  •  The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.

This question was answered by: Caswell Samms, III, vice president and CFO, WellStar Kennestone, and a member of HFMA’s Georgia Chapter.

What do you think? Please share your thoughts on this question in the comments section below.  


The information provided through the Forum’s Ask the Expert service does not constitute legal advice, even when the advice is provided by lawyers. You need to obtain your own legal counsel for legal advice and consider the laws and regulations that govern your state. The content and opinions expressed are those of the Forum experts, and not that of their employers or of HFMA. HFMA does not endorse the material or warrant or guarantee its accuracy. The responses are based only on the specific facts or circumstances provided. Forum experts cannot be held liable for outcomes related to any information provided. 

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