LEASE ACCOUNTING FOR STATE & LOCAL GOVERNMENTS

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1 LEASE ACCOUNTING FOR STATE & LOCAL GOVERNMENTS April 7, 2015 Overview of GASB s Reexamination of Lease Accounting Guidance Andy Richards, CPA Partner arichards@bkd.com 1

2 TO RECEIVE CPE CREDIT Participate in entire webinar Answer polls when they are provided If you are viewing this webinar in a group Complete group attendance form with Title & date of live webinar Your company name Your printed name, signature & address All group attendance sheets must be submitted to within 24 hours of live webinar Answer polls when they are provided If all eligibility requirements are met, each participant will be ed their CPE certificates within 15 business days of live webinar AGENDA Current Guidance Project Background & Considerations Lessee Accounting & Reporting Lessor Accounting & Reporting Other Issues Questions 2

3 CURRENT GUIDANCE GASB lease guidance is nearly identical to FASB current guidance FASB has active lease project underway Potentially significant changes of FASB/IASB project Technical inquiries regarding a GASB update to its leasing guidance CURRENT GUIDANCE National Council on Governmental Accounting (NCGA) Statement 5: Accounting and Financial Reporting Principles for Lease Agreements of State and Local Governments GASB Statement No. 13: Accounting for Operating Leases with Scheduled Rent Increases GASB Statement No. 62: Codification of Accounting and Financial Reporting Guidance Contained in Pre-November 30, 1989 FASB and AICPA Pronouncements Incorporates provisions of FASB Statement No. 13, Accounting for Leases, as amended & interpreted, into GASB s authoritative literature GASB Statement No. 65: Items Previously Reported as Assets and Liabilities 3

4 CURRENT GUIDANCE Even though operating leases represent long-term commitments to make payments, no liabilities are reported, although there are disclosures Likewise, no assets are reported when governments have long-term rights to receive operating lease payments Concepts Statement No. 4, Elements of Financial Statements, established definitions of assets & liabilities Project provides an opportunity for GASB to consider whether operating leases meet definitions of assets or liabilities PROJECT BACKGROUND Objective reexamine issues associated with lease accounting FASB/IASB project Issuance of concepts statements Evaluate standards that have been in effect for a sufficient length of time Research project initiated April 2011 Current agenda project added April 2013 Preliminary views issued November 2014 Comment deadline March 6,

5 PROJECT CONSIDERATIONS Information users needs regarding leases Are current standards appropriate to meet needs Should additional requirements be considered Types of leases Should there be distinction in accounting for different leases Do operating leases meet definitions of assets or liabilities Preliminary Views, Leases 5

6 APPLICATION Definition A contract that conveys the right to use an asset (the underlying asset) for a period of time in an exchange or exchange-like transaction Scope Continue to include contracts not identified as leases but that meet definition Continue existing scope exclusions Contracts for services that do not transfer right to use assets Leases to explore for or use of minerals, oil, natural gas & similar nonregenerative resources Licensing agreements for such items as motion picture films, video recordings, plays, manuscripts, patents & copyrights Service concession arrangements New scope exception for biological assets, including timber APPLICATION Scope Leases that transfer ownership or contain a bargain purchase option be included in leases guidance but be reported as a financed sale or purchase of capital asset Single model No classification of leases into operating/capital or other categories Potentially develop some exceptions Underlying assumption that leases are financings 6

7 LEASE TERM Includes noncancellable period, plus periods covered by a lessee s option to renew, if option is probable of being exercised Excludes periods covered by a lessee s option to terminate, if option is probable of being exercised Excludes periods for which lessee & lessor each have option to terminate Fiscal funding/cancellation clauses ignored if possibility of being exercised is remote Reassessed when change in relevant factors THE LESSEE Accounting & Reporting 7

8 RECOGNITION & MEASUREMENT Recognize an intangible asset for right to use underlying asset & liability for future payments Initial measurement of a lease liability includes Fixed payments to be made over lease term, less any lease incentives Variable payments based on an index or rate, using rate in effect at that date Variable payments that are in-substance fixed Residual value guarantees probable of being required Purchase options probable of being exercised Termination penalties if based on determination of lease term, termination option is probable of being exercised Other payments probably of being paid Liability does not include Lease payments dependent on a lessee s performance or usage of an underlying asset RECOGNITION & MEASUREMENT Lease liability payments should be discounted using rate lessor charges lessee, & if that rate cannot be readily determined, lessee s incremental borrowing rate Initial measurement of a lease asset includes Value of initial lease liability Any prepayments (amounts paid for lease prior to measuring lease liability) Initial direct costs if they are ancillary charges to place leased asset into use Lease incentives received should be reductions in cost of lease assets Initial direct costs should be expensed if they are costs other than ancillary charges to place leased asset into use 8

9 RECOGNITION & MEASUREMENT Lease liability remeasured by calculating amortization on liability & reducing liability for actual payments less amortization Lease asset amortized using a systematic & rational basis over shorter of useful life of underlying asset or lease term Amortize as if lessee owns underlying asset, using lessee s depreciation policy, if lease transfers ownership or if a purchase option is determined to be probable of being exercised Classify amortization of lease asset as amortization expense & amortization of discount on lease liability as interest expense in flows statement REASSESSMENT Reassessment of a lease liability when certain judgments change Lease term Likelihood (probable to not probable or vice versa) of a nonbargain purchase option being exercised Amounts expected to be payable under a residual value guarantee or when there is a change in likelihood (probable to not probable or vice versa) a payment will be required Index or a rate used to determine lease payments during reporting period may be significant Amounts probable of being paid Rate lessor charges lessee 9

10 REASSESSMENT Reassessment of discount rate when Lease term is changed There is a change in likelihood (probable to not probable or vice versa) a purchase option will be exercised Result of a change in reference rate used to determine a variable lease payment may be significant ADJUSTMENT TO LIABILITY Adjustments to lease liability generally should adjust lease asset by same amount Exception: adjustments due to change in rate upon which a variable payment is based should be revenue or expense in the period Exception: if adjustment is greater than carrying value of asset, difference is recognized in flows statement 10

11 RIGHT TO USE ASSET Right-of-use asset in a lease is an intangible asset Accounted for in accordance with existing authoritative guidance for capital assets Relationship between underlying asset & lease asset could mean indicators of impairment present (change in manner or duration of use of lease asset) A change in manner or duration of use of lease asset may indicate impairment of that asset When asset underlying a lease is damaged & requires restoration or replacement, time period during which underlying asset is not usable generally is relevant factor in assessing whether impairment test has been met An impaired lease asset first would be adjusted by any change in corresponding lease liability, with any remaining adjustment recognized as impairment loss SHORT-TERM LEASES Practicality exception for short-term leases A short-term lease is one that, at beginning of lease, has maximum possible term under contract, including any options to extend, of 12 months or less Maximum possible term for a cancellable lease be defined as any noncancellable period, including any notice periods Leases that transfer ownership do not qualify for short-term lease exception, even if they meet other criteria Accounting requirement for all leases that qualify Lessees not required to recognize assets or liabilities associated with right to use underlying asset for short-term leases Lease payments be recognized as expenses/expenditures based on terms of contract 11

12 MULTIPLE COMPONENTS Leases with multiple components Separate contracts into lease & nonlease components or multiple lease components, subject to a practicality exception related to measurement MULTIPLE COMPONENTS Lessees allocate consideration to multiple components 12

13 LESSEE DISCLOSURES Lessees required to disclose the following A general description of leasing arrangements, including basis, & terms & conditions on which variable lease payments are determined, & existence, & terms & conditions of residual value guarantees provided by lessee Total amount of assets recorded under leases, & related accumulated amortization, disclosed separately from owned assets Total variable lease payments actually incurred during reporting period Lease assets disaggregate by major classes of underlying assets A maturity analysis of future minimum lease payments that shows payments for each of first five years & five-year increments thereafter, with payments shown undiscounted & total interest summed for all years LESSEE DISCLOSURES Lessees required to disclose the following Lease commitments, other than short-term leases, for which lease term has not begun Payments made in excess of contractual requirements, such as residual value guarantees or penalties Components of a net impairment loss Amount of expense & expenditure recognized for period related to shortterm leases 13

14 THE LESSOR Accounting & Reporting BALANCE SHEET RECOGNITION Lessor s right to receive payments would be recognized as an asset the lease receivable Fixed payments Variable payments dependent upon an index or rate In-substance fixed payments, including residual value guarantees Does not include variable payments based on performance (e.g., sales or machine hours) Discounted using rate charged to lessee, may be an implicit rate 14

15 REVENUE RECOGNITION Lessor would recognize a deferred inflow of resources Measured at receivable amount plus any cash received upfront at beginning of lease Recognize lease revenue over lease term on a systematic & rational basis Lessor recognizes interest revenue over term of lease receivable INITIAL MEASUREMENT Initial measurement of lease receivable Calculated as discounted future payments to be received during lease term, subject to a provision for uncollectible accounts Recognize expense for initial direct costs in period in which costs are incurred Discount rate used by lessor to determine present value of lease receivable should be rate lessor charges lessee 15

16 LEASE RECEIVABLE Components of lease receivable included in initial measurement Fixed payments required for lease term Variable payments that depend on an index or rate & that are measured using index or rate at beginning of lease Variable lease payments that are in-substance fixed Residual value guarantees that are in-substance equivalent to fixed lease payments RECOGNITION Lessor recognizes revenue from variable payments based on a lessee s usage or performance when it is realizable May be period when performance or usage (on which payments are based) takes place Residual value guarantees recognized as a receivable only when amount of payment has been decided but not yet paid, with revenue recognized (or expense reduced) at that time Payments for exercised purchase options recognized as a receivable & revenue only when options are exercised but not yet paid Termination penalties recognized as a receivable & revenue only when they are exercised but not yet paid 16

17 SUBSEQUENT MEASUREMENT Subsequent measurement of lease receivable by a lessor & related issues Remeasure a lease receivable by calculating amortization of discount on lease receivable & reducing lease receivable by actual lease payment amount less amortization of discount Reassess lease term only when lessee actually extends or terminates lease opposite of what was previously expected Remeasure a lease receivable when result of a change in an index or a rate used to determine lease payments during reporting period may be significant REASSESSMENT Reassessment of discount rate When lease term is changed Change in reference rate included in a variable lease payment Initial selection of a discount rate by lessors also would be approach for selection of a discount rate in event of a reassessment Rate lessor charges lessee 17

18 REMEASUREMENT Impact of remeasurement of lease receivable on other financial elements Adjustment to receivable for a change in lease term would be recognized as an adjustment to related deferred inflow of resources Adjustment to receivable for a change in rate upon which variable payments are based would be recognized as revenue or expense LEASE RECEIVABLE Presentation of lease receivable by lessor Existing guidance on presentation of receivables applies to lease receivables &, therefore, no separate guidance necessary Lessor would not be required to present underlying assets separately from other capital assets Disclose amounts of those assets held for leases in notes to financial statements Guidance on presentation of lease activities in statement of cash flows in lessor s model would be provided through implementation guidance 18

19 LEASED ASSET A depreciable leased asset would be depreciated Unless that asset is required to be returned in its original or enhanced condition Assurance that a leased asset will be returned in its original or an enhanced condition should not be on basis of an asset management system A lessor s lease asset that meets definition of an investment should be reported according to the provisions of GASB Statement No. 72, Fair Value Measurement and Application Measured at fair value if it meets definition of an investment LESSOR DISCLOSURES Disclosures by lessors General description of leasing arrangements, including basis, & terms & conditions, on which variable lease payments are determined Cost & carrying amount, if different, of property on lease or held for leasing By major classes of property Amount of accumulated depreciation Total amount of revenue recognized in reporting period related to leases 19

20 LESSOR DISCLOSURES Revenue relating to variable lease payments & other payments not included in measurement of lease receivable Including revenue related to residual value guarantees & termination penalties A maturity analysis of lease receivable, showing undiscounted cash flows to be received on an annual basis for a minimum of each of first five years & aggregated totals in five-year increments thereafter Reconciled to lease receivable Other Issues 20

21 SUBLEASES Issues relating to subleases Accounted for as transactions separate from their original leases Disclosure of treatment of subleases Subleases would be noted as one of items to be included in general description of lease arrangements (if applicable) Lessor transactions related to subleases would be disclosed separately from original lessee transactions SALE-LEASEBACK TRANSACTIONS Sale-leaseback transaction should include a qualifying sale in order to be eligible for sale-leaseback accounting Sale & leaseback portions of a sale-leaseback transaction should be accounted for separately as a sale transaction & a lease transaction, except that any gain or loss on sale should be deferred over term of lease 21

22 LEASE-LEASEBACK TRANSACTIONS Lease-leaseback transaction should be accounted for as a net transaction, with disclosure of gross amounts for each portion of transaction LEASES WITH CERTAIN COUNTERPARTIES Related-party leases would be recognized based on substance of transaction, when substance is significantly different from form Existing guidance with respect to leases between governments & public authorities would be retained Current treatment for leases with blended component units do not report lease in financial reporting entity s financial statements would be retained Eliminations for internal leasing activity would not take place within financial statements of financial reporting entity; rather, eliminations would take place before financial statements are aggregated Current treatment for leases with discretely presented component units no elimination, but separate presentation of lease receivable & payable would be retained 22

23 WORK PLAN April 2015 Public hearings April - October 2015 Redeliberate issues based on respondent feedback November 2015 Review draft standards section January 2016 Review preballot draft of an Exposure Draft January 2016 (T/C) Review ballot draft & issue Exposure Draft February - May 2016 Due process & comment analysis June - September 2016 Redeliberate issues based on respondent feedback October 2016 Review preballot draft of final Statement November 2016 (T/C) Review ballot draft & issue final Statement QUESTIONS? 23

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25 THANK YOU! FOR MORE INFORMATION Andy Richards, CPA Partner 25