ELA Lease Accountants Conference

Transcription

1 ELA Lease Accountants Conference Advanced Leveraged Leasing Financial Reporting Issues September 21, 2004 Betty Davis Washington, DC

2 Discussion Items: Qualification issues Assumption changes Buying, selling & restructuring Potential future guidance 2

3 Review of Requirements: Finance lease (versus operating or sales type) Three parties Lessor, Lessee and Creditor Financing is nonrecourse and is substantial Lessor s net investment declines in the early years and increases in the later years 3

4 Asset by Asset versus Group Classification: Lease accounting principles applied on an asset by asset basis. Grouping of interdependent assets acceptable (i.e. computer monitor and keyboard) EITF D-107 requires a lessor to obtain residual value insurance for each individual asset in a lease of a group of assets to include in 90% test. 4

5 Direct Finance Lease: Meets one of the tests in paragraph 7 and both of paragraph 8 of FAS 13 (some lease to service contracts have issues under paragraph 8; tax vs. book tension) Carrying value equal to fair value applied literally, no writedowns in anticipation (FTB 88-1) Effectively precludes leveraged lease accounting for existing assets of lessor. 5

6 Nonrecourse Debt Characteristics: Must be unrelated to lessor and lessee (i.e. lessee debt does not qualify) No collateral other than the individual leased property and unremitted rentals Substantial - Nonrecourse debt must be at least 50% of asset s fair value at lease inception and have an outstanding balance for some meaningful period in relation to the lease term. (Prepaid rent structures where third party debt is paid off early can be problematic and disqualify lease at inception) 6

7 Net Investment Test: FAS 13 does not provide specific guidance as to magnitude of decrease and increase. EY view: Decline and increase must be substantive - at least 10% of the initial net investment. Decline and increase should each last for at least one quarter. 7

8 Assumption Changes (paragraph 46): Primary assumptions are estimated residual value and income taxes Residual values are written down if other than temporary decline (no write ups). Residual writedown - Allocation of income is recalculated from the inception of the lease using the lower residual estimate and a cumulative catch up adjustment is recorded. 8

9 Assumption Changes Income taxes: 9 FTB 79-16R all income tax changes are important assumptions as defined in par. 46. Recalculate income only if estimated total net income from the lease changes (i.e. timing changes do not trigger a recalculation of the leveraged lease). Significant for leveraged lessors in AMT, LILO and SILO transactions Income is recalculated in period when new rate or income tax consequences becomes law (i.e. enacted date versus effective date).

10 Assumption Changes Income taxes: Are interest expense and penalties included in assessing whether after tax net income from the lease has changed? Are timing changes that were previously ignored, updated when a future assumption changes total net income? (i.e. state tax rate change after timing only change) When do changes in state tax rates based on changes in apportionment factors impact the leveraged lease model? 10

11 Acquiring Leveraged Leases: FIN 21, Accounting for Leases in a Business Combination, also applicable to purchases of individual leases or portfolios of leases. If the lease terms are not changed, the lease is not reclassified by new owner-lessor. Amount paid becomes new initial net investment. Purchaser in business combination general guidelines of FAS 141 apply value assigned to new initial net investment equal to discounted future cash flows (including tax receipts or payments) 11

12 Selling/Transferring/Exchanging: Rent receivable and any guaranteed residual portion of leveraged lease, sold subject to FAS 140. Unguaranteed residual portion recorded as a sale if substantially all of the risks and rewards of ownership are passed to the purchaser. May need to apply both FAS 140 control model and FAS 13 risks and rewards model (para. 21 and 22) which may result in the entire transaction being treated as a financing. 12

13 Selling/Transferring/Exchanging: In summary, transactions likely will either meet fair value sales recognition with gain or loss recorded, or debt is reflected on balance sheet. As a result of front end loading income recognition, its likely that many leveraged leases investments sold after 4-5 years (depending upon length of lease term) would result in loss recognition. 13

14 Restructuring: Modification to lease agreement/related nonrecourse debt or changed circumstances? No change FAS 5 accrual credit issues Modification look back test (para. 9) Lease extension can new lease be a direct finance lease? Return asset (no lease accounting); timing of writedown issue 14

15 Potential Future Guidance: Revenue Recognition project leveraged lease income recognition model in question. (timing -?; preliminary view document scheduled for 2 nd quarter 2005) FAS 109 Interpretation project on Contingent Tax Benefits (early 2005) 15

16 Contingent Tax Benefits FASB Tentative Conclusions: Require a probable level of assurance to reflect tax benefit (including timing); similar to a should level opinion. Derecognize tax benefit when probable threshold is no longer met. (versus FAS 5 approach of probable that it will be lost) Difference between as filed tax basis and tax basis meeting probable level of assurance reflected as a current liability not deferred tax. Impact on leveraged leases (generally not subject to FAS 109) is uncertain. In practice, should level typically applied for initial recording in leveraged lease cash flows. 16