Insights into IFRS Lease Accounting

Transcription

1 Insights into Accountants Group in Germany 54th AGiG Seminar 7 November 2006 WP StB CPA Karsten Ganssauge PwC International Reporting Group PwC

2 Agenda US-GAAP Lease Accounting German GAAP Lease Accounting

3 Section one Lease Classification Accounting Consequences of Lease Classification Applications & Challenges in Practice US-GAAP Lease Accounting German GAAP Lease Accounting

4 Section one Lease Classification Accounting Consequences of Lease Classification Applications & Challenges in Practice US-GAAP Lease Accounting German GAAP Lease Accounting

5 - Lease Classification Lease Classification - Relevant IFRS Guidance IAS 17 Leases Interpretations related to IAS 17: - SIC-27 Evaluating the substance of transactions involving the legal form of a lease - IFRIC-4 Determining whether an arrangement contains a lease Other guidance, eg. - SIC-12 Special Purpose Entities - IAS 39 Financial Instruments Recognition and Measurement - IASB Updates and IFRIC Updates - Related US GAAP guidance, eg. FAS 13 Accounting for leases Slide 5.

6 - Applications & Challenges in Practice IAS 17.4 Lease classification what is a lease? A lease is an agreement whereby the lessor conveys to the lessee in return for a payment or a series of payments the right to use an asset for an agreed period of time Use of an asset Lessee Lessor Cash Slide 6

7 - Lease Classification Lease Classification IAS 17 IAS 17.7 IAS 17.8 IAS Classification of leases ( ) in this Standard is based on the extent to which risks and rewards ( ) of a leased asset lie with the lessor or the lessee. Yes Transfer of substantially all risks and rewards? No Finance Lease Operating Lease Indicators for lease classification: IAS (a)-(e), (a)-(c) Slide 7.

8 - Applications & Challenges in Practice IAS Lease classification: Finance vs. Operating Leases Indicators for lease classification: IAS (a) Transfer of ownership (b) Bargain purchase option (c) Lease term is for majority of economic life (>75%)* (d) PV of MLP = at least subtantially all of the FV (>90%)* (e) Specialised nature of leased asset IAS (a) Lessee bears costs of cancellation (b) Gains/ losses from FV fluctuation accrue to lessee (c) Bargain renewal option * no bright line Slide 8.

9 - Lease Classification IAS IAS Lease Classification Lease classification is made at the inception of the lease - unless change in the contractual terms Classification on an asset-by-asset basis Leases of land and buildings: - Elements are considered separately for lease classification - Allocation not based on relative fair values - Land element is normally classified as an operating lease unless title is expected to pass Slide 9.

10 - Applications & Challenges in Practice IFRIC-4 Lease classification practical examples Simplified SPE structure Leasing Company Lessee Use of an asset Cash X% Y% Lessor SPE Loan Cash Bank Often combined with: Hereditary building rights Purchase options Renewal options Financial guarantees etc. Asset Manufacturer Cash Slide 10

11 - Applications & Challenges in Practice IFRIC-4 Lease classification other practical examples Sale-leaseback-structures Finance or operating Sub-Lessee Leaseback Sublease Lessee Lessor (SPE) Loan Bank Cash Sale Cash Slide 11

12 - Applications & Challenges in Practice IFRIC-4 Lease classification other practical examples Indirect leases Manufacturer Continuing involvement* Bank Lease Lessee Sale Cash * e.g. buyback obligation or financial guarantee or remarketing agreement with profit sharing Slide 12

13 Section one Lease Classification Accounting Consequences of Lease Classification Applications & Challenges in Practice US-GAAP Lease Accounting German GAAP Lease Accounting

14 - Accounting Consequences of Lease Classification IAS Accounting Consequences of Lease Classification Initial recognition - overview Finance lease Operating lease Lessor Lease receivable (@ net investment in the lease ) Asset Lessee Asset (@ FV or lower PV of MLP) plus lease liability Slide 14.

15 - Accounting Consequences of Lease Classification IAS IAS Accounting Consequences of Lease Classification Subsequent accounting Finance lease Finance lease Lessor Lease receivable Lessee Asset FV or lower PV of MLP) plus lease liability Subsequent measurement Split into finance income and reduction of receivable Constant periodic rate of return Split into finance charge and reduction of liability Constant periodic rate of return Finance charges + depreciation Slide 15.

16 - Accounting Consequences of Lease Classification Accounting Consequences of Lease Classification IAS IAS Subsequent accounting Operating lease Operating lease Lessor Asset (presented according to nature) Lessee Subsequent measurement Lease income is recognised in P&L (normally straight-line) Costs incurred in earning the lease income (incl. depreciation) are recognised as an expense Lease expenses are recognised as an expense over the lease term (normally straight-line) Slide 16.

17 Section one Lease Classification Accounting Consequences of Lease Classification Applications & Challenges in Practice Classification: Finance vs. Operating Leases SPE Consolidation Issues Embedded Leases US-GAAP Lease Accounting German GAAP Lease Accounting

18 Section one Lease Classification Accounting Consequences of Lease Classification Applications & Challenges in Practice Classification: Finance vs. Operating Leases SPE Consolidation Issues Embedded Leases US-GAAP Lease Accounting German GAAP Lease Accounting

19 - Applications & Challenges in Practice IAS Classification: Finance vs. Operating Leases Reminder: Indicators for lease classification: IAS (a) Transfer of ownership (b) Bargain purchase option (c) Lease term is for majority of economic life (>75%)* (d) PV of MLP = at least subtantially all of the FV (>90%)* (e) Specialised nature of leased asset IAS (a) Lessee bears costs of cancellation (b) Gains/ losses from FV fluctuation accrue to lessee (c) Bargain renewal option * no bright line Slide 19.

20 - Applications & Challenges in Practice IAS Classification: Finance vs. Operating Leases Criteria individually or in combination normally point to the existence of a finance lease - Relevance of individual criteria - Criteria are only indicators No straightforward check list to determine lease type unless transaction is of a simple structure. Accounting policy manuals Slide 20.

21 - Applications & Challenges in Practice Classification: Finance vs. Operating Leases IAS 17.10(b) IAS 17.10(d) IAS 17.11(b) Common pitfalls Bargain purchase options Present value of minimum lease payments (MLP) Residual value gains/losses accruing to the lessee Let s take a closer look Slide 21.

22 - Applications & Challenges in Practice IAS 17.10(b) Classification: Finance vs. Operating Leases Bargain purchase option Look at effect of option rather than on strike price only - Example: option is at future fair value, combined with penalty reasonably certain - look at probabilities based on strike price - not other considerations, such as management strategy or other non-risk/benefit-considerations If bargain purchase option: - include strike price in MLP / PV test - effects on distribution of gains and losses Slide 22.

23 - Applications & Challenges in Practice IAS 17.10(d) Classification: Finance vs. Operating Leases Present value of MLP FAS 13 indicator (90%), but cannot be applied as a checklist Often calculations do not include all relevant costs Watch out for terms & conditions outside of the lease contract! - transaction expenses - costs for operation of SPE (incl. income taxes) - general terms & conditions - stakeholdings in lessor SPE Potential problem in mass business (eg manufacturer lessors) Slide 23.

24 - Applications & Challenges in Practice IAS 17.11(b) Classification: Finance vs. Operating Leases Residual value gains/losses accruing to the lessee consider options watch out for agreements outside of lease contract Slide 24.

25 Section one Lease Classification Accounting Consequences of Lease Classification Applications & Challenges in Practice Classification: Finance vs. Operating Leases SPE Consolidation Issues Embedded Leases US-GAAP Lease Accounting German GAAP Lease Accounting

26 - Applications & Challenges in Practice SPE Consolidation Issues SIC-12 - a must consider issue in many leasing transactions Looking at lease classification under IAS 17 only has limited value Consider whether lessor is consolidated SPE = entity with narrow and well-defined objective Interpretation of IAS 27 control model in SIC-12: - An SPE shall be consolidated when the substance of the relationship between an entity and the SPE indicates that the SPE is controlled by the entity - Consolidation may be required even if lessee does not hold any voting rights! Slide 26

27 - Applications & Challenges in Practice SIC SPE Consolidation Issues Indicators of control under SIC-12: (a) in substance, the activities of the SPE are being conducted on behalf of the entity according to its specific business needs so that the entity obtains benefits from the SPE s operation; (b) in substance, the entity has the decision-making powers to obtain the majority of the benefits of the activities of the SPE or, by setting up an "autopilot" mechanism, the entity has delegated these decisionmaking powers; (c) in substance, the entity has rights to obtain the majority of the benefits of the SPE and therefore may be exposed to risks incident to the activities of the SPE; or (d) in substance, the entity retains the majority of the residual or ownership risks related to the SPE or its assets in order to obtain benefits from its activities. Slide 27.

28 - Applications & Challenges in Practice SIC SPE Consolidation Issues Qualitative vs. quantitative factors: Relationship and Models Qualitative factors: Activities on behalf of entity decision making / autopilot Quantitative factors: Risks Rewards Slide 28.

29 - Applications & Challenges in Practice SIC IAS SPE Consolidation Issues Transfer of risks and rewards No guidance in SIC-12! What are risks and rewards? Which risks and rewards are relevant? What is meant by transfer of risks and rewards? Slide 29

30 - Applications & Challenges in Practice SIC IAS SPE Consolidation Issues Risks and rewards IAS 39 - variability in the amounts and timing of the net cash flows of the transferred asset - Upside (downside) potential from deviations between expected and actual cash flows When is there a transfer? - An entity has transferred substantially all the risks and rewards of ownership ( ) if its exposure to such variability is no longer significant in relation to the total variability in the present value of the future net cash flows associated with the financial asset. Slide 30

31 - Applications & Challenges in Practice SPE Consolidation issues SIC IAS borne by lessee Probability only for demonstration purposes - not to scale borne by the bank, the dormant partner and the general partner 4,800 8,300 9,195 E(RFV) = 9,200 Residual fair value in K Slide 31

32 - Applications & Challenges in Practice SIC IDW RS HFA 2, Tz. 65 SPE Consolidation Issues Reminders When assessing risks and rewards, consider: what is meant by risks & rewards? which risks & rewards exist and which are relevant? risks & rewards of entity vs. risks & rewards of leased asset statistical analysis and expert opinions may be required! Slide 32

33 - Applications & Challenges in Practice SIC IDW RS HFA 2, Tz. 65 SPE Consolidation Issues - Reminders Judgement required Often lessee will consolidate Sometimes the SPE is not (exclusively) designed to specifically serve the purposes of one of the parties involved However, consider facts & circumstances if other parties involved in setting up the SPE clearly bear the majority of risks & rewards Slide 33

34 Section one Lease Classification Accounting Consequences of Lease Classification Applications & Challenges in Practice Classification: Finance vs. Operating Leases SPE Consolidation Issues Embedded Leases US-GAAP Lease Accounting German GAAP Lease Accounting

35 - Applications & Challenges in Practice IFRIC-4 Embedded Leases Why accounting guidance for embedded leases? Contracts may have economic substance of a lease agreement, eg: - purchase contracts - servicing contracts - outsourcing contracts Look out for specific assets where the entity receives substantially all of the output of that asset - Look at substance rather than form - Such agreements may need to be accounted for as a lease Determining whether an arrangement contains a lease - Defining the term specific asset - Defining the scope of usage Slide 35

36 - Applications & Challenges in Practice IFRIC-4 Embedded Leases Assets within scope of IAS 17? No CONTINUE HERE Yes No Specific asset explicitly identified? No Yes Asset implicitly specified? Yes Fulfillment of arrangement dependent on use of specific asset? No No No Facts and circumstances indicate that it is remote that one or more parties other than the purchaser will take more than an insignificant amount of the output/ other utility produced or generated by the asset during the term of the arrangement Yes Yes Purchaser has ability or right to operate the asset or direct others to operate the asset in a manner it determines while obtaining or controlling more than an insignificant amount of the output/utility of the asset? No Yes Yes Price the purchaser pays is either contractually fixed per unit of output or equal to the current market price per unit of output as of time of delivery Purchaser has ability or right to control physical access to the underlying asset while obtaining more than an insignificant amount of the output/utility of the asset? No CONTINUE ON RIGHT HAND Yes Arrangement does not contain a lease No Arrangement contains a lease Slide 36

37 - Applications & Challenges in Practice IFRIC-4 Embedded Leases Embedded lease? Supply contract - delivery of steam & electricity B Darlehen 750 Mio. Power Plant Slide 37

38 - Applications & Challenges in Practice IFRIC-4 Embedded Leases A Utility company Leasing Company 100% Supply contract - delivery of steam & electricity 100% Lease 100% B SPE (power plant) Lessor SPE Loan Bank Sale of steam-electricity plant Slide 38

39 - Applications & Challenges in Practice IFRIC-4 Embedded Leases Determining whether an arrangement contains a lease Specific asset Purchaser exclusively entitled to use the asset Usage of the asset is explicitly defined within the contract Service provider has just one asset suitable to fulfil his part of the contract There is only one (unique) asset (e.g intellectual property) Used asset is implicitly defined by the terms of the transaction Usage of other assets technically not possible Usage of other assets technically possible, but not feasible from an economic point of view The asset is a specific asset, if (from an economic point of view) fulfilment of the contract is only possible via the usage of the asset Slide 39

40 - Applications & Challenges in Practice IFRIC-4 Embedded Leases Determining whether an arrangement contains a lease Specific asset - No embedded lease, if fulfilment is not dependent on the usage of the specified asset, but can also be effected using another asset or the service provider is able to fulfil the contract using other assets. - A right or commitment by the service provider to exchange the asset in case of a malfunction or at regular intervals does not preclude the existence of a specific asset. Use of the asset: - Direct physical control (ability or right to operate) over the asset, or - Control physical access to the asset - Purchaser takes significant part of the output contractually fixed price per unit of output or current market price per unit of output as of time of delivery. Slide 40

41 Section two US-GAAP Lease Accounting German GAAP Lease Accounting

42 Section two US-GAAP Lease Accounting Differences to IFRS German GAAP Lease Accounting

43 US-GAAP Lease Accounting - Differences to IFRS FAS FAS US GAAP Guidance FAS 13 Accounting for leases -Overview Scope: does not apply to intangibles Lease classification generally similar, but devil is in the detail: - Lessee: capital or operating - Lessor: sales-type, direct financing, leveraged or operating - US-GAAP bright-line guidance Detailed and complex guidance for changes in provisions, contract renewals and terminations Slide 43

44 - Lease Classification US GAAP Guidance FAS 43/EITF FAS 98/FAS 66 EITF EITF 97-1 Q2 Complex rules for real estate leases, eg Integral Equipment Real estate sale-and-lease back Built-to-suit leases Non-performance default provision Slide 44.

45 - Lease Classification FAS 43/EITF US GAAP Guidance Integral Equipment If an asset is considered an integral equipment, the real estate lease guidance needs to be applied Integral equipment: Any physical structure or equipment attached to the real estate that cannot be removed and used separately without incurring significant cost EITF defines what "cannot be removed and used separately without incurring significant cost" means Slide 45.

46 - Lease Classification FAS 98/FAS 66 US GAAP Guidance Real estate sale-and-lease back All of the following criteria must be met - The lease must be a normal leaseback - A sale has occurred - No form on continuing involvement by the seller-lessee Examples: - Repurchase option or obligation - Seller-lessee guarantees the buyer-lessor s investment or return on that investment - Residual value guarantee If any criteria are not met, seller accounts for the transaction as a financing (i.e. Dr. cash, Cr. financing obligation) Slide 46.

47 - Lease Classification EITF US GAAP Guidance Built-to-suit leases Examples: Lessee is involved in the construction or asset will be leased to the lessee upon construction completion If BTS, the accounting consequences are as follows: - Future lessee is deemed the owner of the asset during the construction period - Upon construction completion, lease must be accounted for as a sale-leaseback Slide 47.

48 - Lease Classification EITF 97-1 Q2 US GAAP Guidance Non-performance default provision Framework to evaluate effect of default provisions unrelated to lessee s use of the leased asset on lease classification Non-performance default provisions do not affect lease classification if certain conditions are met Failure to comply with the criteria results in the inclusion of the maximum remedy in the 90% test (almost always resulting in a capital lease)!!! Slide 48.

49 Major differences between IFRS and US GAAP (1/4) Difference Scope Economic life test and PV test Lease of specialized asset Discount rate Implicit interest rate IFRS IAS 17 also applies to intangibles No fixed percentages Classified as a finance lease Implicit interest rate if known or determinable, otherwise the incremental borrowing rate Needs to be determined if the lessee has sufficient information to determine the lessor s implicit interest rate US GAAP FAS 13 does not apply to intangibles Fixed percentages (75% & 90%) Classified based on the general four criteria or specific guidance (e.g. BTS leases) The lower of the implicit interest rate or the incremental borrowing rate Generally not applied if the lessor does not share his calculation with the lessee Slide 49

50 Major differences between IFRS and US GAAP (2/4) Difference Bifurcation of land & building element Bifurcation of MLP for leases involving land & building Integral equipment Lease of a portion of a building IFRS Not required if land element is immaterial; 25% threshold may be too high; facts and circumstance based Based on the relative fair value of the leasehold interest No such concept No such simplification rule; however, application issue US GAAP Only required if land element is equal to or exceeds 25% of the total FV of the leased asset MLP relating to land is determined by applying the IBR to the FV of the land Real estate lease guidance is applied to integral equipment Only the 75% needs to be applied if the FV of the portion of the building is not readily determinable Slide 50

51 Major differences between IFRS and US GAAP (3/4) Difference Economic life test Sale & Lease-back (gain/loss recognition) Sale & Lease-back (sale treatment) Built-to-suit leases IFRS Always applied; no such exception Different gain/loss recognition rules apply under both GAAPs No such restrictive rules; the general SLB criteria apply No such concept; however, BTS leases might be indicative for finance lease or specific asset; currently analyzed by the Lease Working Group of Global ACS Not applied if lease inception is during the last 25% of the economic useful life of the leased asset See IFRS US GAAP Specific, very restrictive rules for sale treatment (e.g. continuing involvement) Detailed guidance; Future lessee is often considered the owner of the asset during construction Slide 51

52 Major differences between IFRS and US GAAP (4/4) Difference Non-performance default provision Consolidation Lessor accounting Terminology Participation of third parties Embedded leases IFRS No such concept SIC-12 No additional criteria Finance lease No explicit guidance IFRIC-4 US GAAP Not meeting any of the four criteria often times leads to capital lease treatment FIN 46(R) generally has a wider scope and different approach to determine primary beneficiary of the VIE FAS 13 has 2 additional criteria for lessors Capital lease Guidance on sale-leasebacksublease transactions and on sales of assets intended to be leased out by the 3rd party (where seller retains risks) EITF does not apply to intangibles and does not demand retrospective application Slide 52

53 Section three US-GAAP Lease Accounting German GAAP Lease Accounting

54 German GAAP Lease Accounting German GAAP Lease Accounting No explicit guidance in German Commercial Code (HGB) Accounting generally follows tax rules published by the Ministry of Finance in 1971, 1972, 1975 and 1991 which distinguish between movable property and real estate and between full amortisation and partial amortisation contracts (ie where lease payments cover cost plus financing either fully or only partially) In simplified terms: Full amortisation contracts are finance leases, if: - the basic lease period is either < 40% or > 90 per cent of the economic life of the leased asset; or - the basic lease period is 40%-90% of the economic life and a purchase option or an option to extend the lease period exists and strike price of purchase option is net book value; or scheduled lease payments after the basic lease period are less than the depreciation expense using the straight-line method. Additional rules for certain situations (eg partial amoritisation contracts, specialised leased assets, etc.) Slide 54

55 Thank you! All rights reserved. refers to the German firm AG WPG and the other member firms of International Limited, each of which is a separate and independent legal entity. PwC

56 Contact WP StB CPA Karsten Ganssauge International Reporting Group Frankfurt Office: +49 (69) Fax: +49 (69) Mobile: +49 (160) All rights reserved. refers to the German firm AG WPG and the other member firms of International Limited, each of which is a separate and independent legal entity. PwC