Now & Next 973.822.2220 (ASC 840 f/k/asfas 13) Learning Objectives: To review recent developments in lease accounting and demonstrate how they have affected accounting for leases as prescribed under SFAS 13, Accounting for Leases. Program Prerequisites: None Program/Course Level: Overview Program Content: Lease accounting has been one of the most controversial accounting topics for nearly two decades. This program will begin with a quick overview of the current accounting for leases within ASC 840 (SFAS 13). The focus of the program will be to address the current exposure draft on Leases, the significant rule changes, the impact on both the lessee and lessor, impact on preexisting leases and comment letters associated with this topic. Advanced Preparation: None Type of Delivery Method: Live & Group Internet Based CPE Credits: 2 2 1
3 Developments in Lease Accounting FASB Proposed ASU 4 2
Developments in Lease Accounting FASB Proposed ASU 5 I. Overview A lease is a contractual agreement between a lessor, who conveys the right to use real or personal property (an asset), and a lessee, who agrees to pay periodic rents over a specified time. Rental Sale Lessee Operating Lease Capital Lease Lessor Operating Lease Sales Type or Direct Financing Type 6 3
II. Operating Leases A. Definition An operating lease includes a lessor, who collects rent, and a lessee, who uses the leased asset and pays periodic rent for such use. The lessee merely uses the asset; there is no transfer of ownership, or of any risk or benefit of ownership. 7 B. Accounting for Operating Leases 1. Lessee Accounting a. Lease Rent Expense The lessee records rent expense over the lease term, usually on a straight-line basis unless other methods are warranted (for example, lease expense can be tied to sales, to the Consumer Price Index, or to the prime interest rate). DR Rent expense $XXX CR Cash/rent payable $XXX 8 4
b. Lease Bonus (Prepayment) Lease bonus (prepayment) for future expenses should be classified as an asset (deferred charge) and amortized using the straight-line method over the life of the lease. c. Leasehold Improvements A leasehold ld improvement is one that t is permanently affixed to the property and reverts back to the lessor at the termination of the lease. In general, if the property is not moveable from the premises by the tenant, it is a leasehold improvement. Air conditioning ducts would be considered a leasehold improvement, while a painting hanging on a wall would not. 1) Capitalize Leasehold Improvements The value of leasehold improvements should be capitalized and added to the property, plant, and equipment section or the intangible assets section of the balance sheet. 2) Depreciation Useful Life or Lease Term Leasehold improvements should be depreciated (amortized) over the lesser of: a) Lease life b) Asset/improvement life d. Rent Kicker A premium rent payment required for specific events. 1) Period expense e. Refundable Security Deposit Is reported as an asset until refunded by the lessor. 9 f. Free or Reduced Rent Consideration If consideration (free rental months or reduced rental charge at beginning) is part of the package, lessee must take total rent expense to be paid for the entire lease term and divide it evenly over each period (matching principle). XAMPLE EX 5 years (60 months) @ $1,000 *First 6 months are free Net cost for five years Total months rented Monthly rental expense First 6 months ( Mo. 1 6) Rental-Agreement $60,000 <6,000> $54,000 60 mo. $ 900 DR Rent expense $900 CR Rent payable $900 Next 54 months (Mo. 7 60) DR Rent expense $900 DR Accrued rent payable 100 CR Cash/rent payable $1,000 10 5
C. Leasing Issues 1. Background and evolution a. Restatements b. SEC Staff Letter 2. Primary issues a. Amortization of leasehold improvements b. Rent holidays c. Lease incentives d. Disclosures 11 Issue 1: Amortization of Leasehold Improvements Amortized by lessee over the shorter of: Their economic lives Lease term (as defined in ASC 840, f/k/a SFAS 13) Amortization of LHIs over a term that includes renewals is appropriate only when renewals have been determined to be "reasonably assured" A lease that is cancelable only upon the occurrence of some remote contingency, only with the permission of the lessor, only if the lessee enters into a new lease with the same lessor, or only if the lessee incurs a penalty in such amount that continuation of the lease appears, at inception, reasonably assured... is considered non-cancelable KEY POINT Leasehold improvements cause renewal option to be "reasonably assured: when: 1. LHIs are expected to have significant value at end of initial period such that lessee is not willing to abandon these assets (i.e. effectively incur a penalty) 2. Renewal option reasonably assured of exercise 3. Add the renewal period to the initial term to determine appropriate term for accounting purposes 12 6
Issue 2: Rent Holidays Apply ASC 840-20-25; 25; f/k/a/ FASB Technical Bulletin 85-3, "Accounting for Operating Leases with Scheduled Rent Increases" Operating leases with rent holidays should be recognized: 1. On a straight-line basis 2. Over the lease term 3. Including the rent holiday period: lease term for accounting purposes includes all periods lessee has access to and control over leased space. Straight-line applies unless another systematic or rational allocation is more representative of the time pattern in which the leased property is physically employed. 13 Issue 3: Lease Incentives Landlord incentives for Leasehold Improvements: 1. Acquisition of LHI is capitalized asset 2. Incentive received recorded as a deferred rent by lessee 3. Amortize incentive as reduction to lease expense over the lease term 4. Cash Flow Statement a. Acquisition of the leasehold improvement in "investing activities" b. Proceeds of incentive as "operating activities" 14 7
Issue 4: Disclosures Amortization Period For LHIs Material Lease Agreements Disclosures: Footnotes, MD&A Critical Accounting Policies Accounting Policies for Leases Basis for Contingent Rents Provisions of Material Leases original term, renewal periods, reasonably assured rent escalations, rent holidays, contingent rent, rent concessions, LHI incentives and other unusual provisions 15 2. Lessor Accounting a. Fixed Asset The cost of the property is included in the lessor's property, plant and equipment. 1) Depreciation over the asset's useful life b. Rental Income Rental income is reported on either the straight-line or other systematic method. DR Cash/rent receivable $XXX CR Rental income $XXX 16 8
c. Security Deposits Security deposits required by the lease may be either refundable or nonrefundable: 1) Nonrefundable deferred by the lessor (unearned revenue) and capitalized by the lessee (prepaid rent expense) until the lessor considers the deposit earned. 2) Refundable treat as a receivable by the lessee and a liability by the lessor until the deposit is refunded d to the lessee. DR Cash $XXX CR Refundable deposit $XXX 17 KEY POINT Do not recognize security deposits as revenue in advance of their being earned (violation of the Rule of Conservatism). Remember, revenue is only recognized when the earning process is complete; we never anticipate revenue. d. Temporary Difference 1) GAAP Rule report prepaid rental income when earned 2) Tax Rule report prepaid rental income when received e. Lease Bonus The lease bonus is deferred (unearned income) and amortized (into income) over the life of the lease. 18 9
f. Free or Reduced Rent Consideration If consideration (free rental months or reduced rental charge at beginning) is part of package, lessor must take total rental income to be paid for the entire lease term and divide it evenly over each period (matching principle/revenue recognition principle). EXAM MPLE Rental-Agreement 5 years (60 months) @ $1,000 *First 6 months are free Net rental income for five years Total months rented $60,000 <6,000> $54,000 60 mo. Monthly rental income $ 900 First 6 months ( Mo. 1 6) DR Accrued rent receivable $900 CR Accrued rental income $900 Next 54 months (Mo. 7 60) DR Cash $1,000 CR Rental income $900 CR Rent receivable 100 19 III. Capital Lease A capital lease transfers substantially all of the benefits and risks inherent in ownership of property p to the lessee. i. This is an accounting transaction, which is, in substance, an installment purchase in the form of a leasing arrangement. ii. The lessee accounts for this type of lease as the acquisition of both an asset (leased asset under capital lease) and a related liability (obligation under capital lease). iii. The lessor accounts for such a lease as a sales-type or a direct financing lease. A sales-type lease results in a dealer's or manufacturer's profit or loss to the lessor. A direct financing lease does not result in a dealer's or manufacturer's profit or loss. 20 10
A. Lessee Capital Lease Criteria 1. Must meet just one condition to capitalize. DR Fixed asset leased property $XXX CR Liability obligation under capital lease $XXX Ownership transfers at end of lease (upon final payment or required buyout) Written option for bargain purchase Ninety (90%) percent of leased property F.V. <= P.V. of lease payments Seventy-five y (75%) percent of asset economic life is being committed in lease term 2. Criteria (N) and (S) cannot be used for a lease that begins within the last 25% of the original estimated economic life of the leased property. 21 EXAMPLE Equipment FV is $3,500, lease payments are $1,000 per year, on 12-31 lease term is four years, asset life is ten years. Incremental borrowing rate is 10% No ownership No written bargain FV P.V. Cost 1 2 3 4 $3,500 x 90% $3,150 $ 910 830 750 680 $3,170 $1,000 $1,000 $1,000 $1,000 22 11
B. Lessor: Sales-Type/Direct Financing Type Criteria 1. If a lease, at inception, meets all three of the following conditions, it shall be classified by the lessor as a sales-type or direct financing lease, whichever is appropriate. Lessee "owns" the leased property (meets any one of the four lessee's criteria) Uncertainties do not exist regarding any unreimburseable costs to be incurred by the lessor. Collectibility of the lease payments is reasonably predictable. 23 IV. Lessee (Capital Lease) Accounting A. Calculation of Leased Asset and Liability Amounts The lessee treats the capital lease as if an asset were being purchased over time; that is, it is a financing transaction in which an asset is acquired and a corresponding obligation (liability) is created. DR Fixed asset leased property $XXX CR Liability obligation under capital lease $XXX 24 12
1. Recording the Lease a. Capitalized Amount The lessee records the lease as an asset and a liability at the lower (lesser) of: 1) Fair value of the asset at the inception of the lease, or 2) Cost = present value of the minimum lease payments. 25 a) Includes (all payments that the lessee is obligated to make): 1) Required Payments 2) Bargain Purchase Option When the lease contains a bargain purchase option, the lease obligation includes the present value of the payment required to exercise the bargain purchase option in addition to the present value of the minimum lease payments. 3) Guaranteed Residual Value The guaranteed residual value is the amount guaranteed by the lessee to the lessor for the estimated residual value of the asset at the end of the lease term. b) Exclude: 1) Executory Costs Insurance, maintenance, and taxes can be paid by the lessor or lessee. If the lessor pays them, a portion of each lease payment representing executory costs is excluded from the calculation of minimum lease payments. If the lessee pays these costs directly, they are not included in the minimum lease payments. 2) Optional Buyout (not required and not a bargain) 26 13
Periodic payment KEY POINT Bargain OR PV of $1 Guaranteed residual Beginning = PV of an annuity due Ending = PV of an annuity (in arrears/ordinary) 27 b. Interest Rate The lessee uses the incremental borrowing rate, determined d as the lower (lesser) of: 1) Rate implicit in the lease (if known) 2) Rate available in market to lessee (not prime) 28 14
c. Summary Capitalized Cost (remember, lower of this cost or market): O wnership = PV of payments and required buyout (if any) W ritten = PV of payments and bargain buyout N inety % FV = PV of payments (not option buyout) S eventy five % life = PV of payments (not option buyout) 29 B. Term to Use in Computing Depreciation of the Asset 1. Formula for Depreciation Capitalized lease assets < Salvage value> Depreciable Basis Periods of benefit Depreciation Expense (per period) 30 15
2. Period of Benefit (Depreciable Life) a. Ownership Transfer and Written Bargain 1) Estimated economic life of the asset if the lessee takes ownership of the leased asset by the end of the lease or if there is a bargain purchase option as part of the agreement. The asset is depreciated in a manner consistent with the lessee's normal policies. b. Ninety % FV and Seventy-five % Life 1) The lessee uses the lease term if the lessee does not take ownership of the asset by the end of the lease or if there is not a bargain purchase option. 31 3. Summary Depreciation Rules: (Capitalized "lease" asset salvage salvage value): Ownership = Depreciate over asset life (legal form) Written = Depreciate over asset life (legal form) Ninety % FV = Depreciate over lease life (substance over form) Seventy five % life = Depreciate over lease life (substance over form) 32 16
E. Summary of Lessee Capitalization Rules 1. Capitalize As PP&E on the balance sheet, the leased asset at the lower LESSER of: a. Cost PV of future lease payments Include: Guaranteed Residual Value by Lessee, Bargain Purchase Option (if applicable) Exclude: "Executory Cost" = Insurance, Taxes, and Repair & Maintenance 1) Discount Rate: Incremental borrowing rate is the lower (LESSER) of: a) Rate implicit in the lease (if known) b) Rate available in market to lessee (not prime) b. Fair Value Capitalize Depr. Life Ownership = PV of payments and required buyout Asset life Written = PV of payments and bargain buyout Asset life Ninety % FV = PV of payments (ignore option) Lease life Seventy-five % life = PV of payments (ignore option) Lease life 33 KEY POINT If a lease meets more than one of the criteria, then the order of priority for applying the rules is the exact way they are spelled: O W N S 34 17
V. Lessor Accounting 35 A. Recording a Sales-Type Lease Following are the terms which are important to know for sales-type leases: 36 18
1. Gross Investment (lease receivable) The minimum lease payments plus any unguaranteed residual value accruing to the benefit of the lessor. This is recorded as Lease Payments Receivable on the lessor's books. Lease payment + Unguaranteed residual value Gross investment 37 2. Net Investment This is computed as the sum of the present value of the minimum lease payments and the present value of any unguaranteed residual value accruing to the benefit of the lessor, using the interest rate implicit in the lease. Lease payments + Unguaranteed residual value Gross investment x PV Net investment 38 19
3. Unearned Interest Revenue (Contra-Lease Receivable) The gross investment less unearned interest revenue equals net investment. This is amortized over the life of the lease by the effective interest method and is included in the balance sheet as a deduction from the gross investment to report the net investment. Gross investment < Net investment > Unearned interest revenue 39 4. Cost of Goods Sold The cost of the leased asset plus any initial direct costs, such as legal fees or commissions to the lessor, minus the present value of any unguaranteed residual value accruing to the lessor's benefit. This is charged against income in the period in which the corresponding sale is recorded. Cost of Asset < PV Unguaranteed Residual > Cost of Goods Sold 40 20
5. Sales Revenue The present value of the minimum lease payments is recorded as sales revenue. This does include the present value of any guaranteed residual value but does not include the present value of any unguaranteed residual value. 41 EXAMPLE Recording a Sale-Type Lease with Unguaranteed Residual Value (Lessor Lessor) Assume that a lease with a ten-year term requires rental payments of $5,000 on January 1 of each year. The lessor's cost for the leased asset is $35,000. The estimated fair value at the end of the lease (unguaranteed residual value) is $4,000, and the lessor retains ownership at the end of the lease. The implicit interest rate is 10 percent (P.V. of annuity due is 6.759 and PV of $1 is.386). Compute the information necessary to record this sales-type lease. 42 21
EXAMPLE (continued) 1. Gross investment = Minimum lease payments + Unguaranteed residual value = ($5,000 x 10 yrs) + $4,000 = $54,000 43 EXAMPLE (continued) 2. Net investment = Lease payments x PV of annuity due of $1, 10 periods, 10% + Unguaranteed residual value x PV of $1, 10 periods, 10% = ($5,000 x 6.759) + ($4,000 x.386) = $35,339 (The present value of the minimum lease payments, but not the unguaranteed residual value, is recorded as sales, $5,000 x 6.759 = $33,795) 44 22
EXAMPLE (continued) 3. Unearned interest revenue = Gross investment Net investment = $54,000 $35,339 = $18,661 45 EXAMPLE (continued) 4. Cost of goods sold = Lessor s cost of leased asset + Initial direct costs PV of unguaranteed residual value = $35,000 + 0 ($4,000 x PV of $1, 10 periods, 10%) = $35,000 (4,000 x.386) = $33,456 46 23
EXAMPLE (continued) 5. Present value of lease payments (sale) = $5,000 x 6.759 = $33,795 47 EXAMPLE (continued) Journal Entry: To record this sales-type lease DR Lease payments receivable $54,000 DR Cost of goods sold 33,456 CR Sales $33,795 CR Equipment 35,000 CR Unearned interest revenue (contra-lease receivable) 18,661 Note: The lessor s profit on sale is $33,795 $33,456 = $339, which is recognized at the lease s inception. 48 24
B. Recording a Direct Financing Since no manufacturer's or dealer's profit is realized in a direct financing lease, the fair value of the leased property p equals the cost or carrying value at the inception of the lease. The information necessary to record this type of lease is: 49 1. Gross Investment (Lease Receivable) Gross investment equals the minimum lease payments plus the unguaranteed residual value and is recorded as Lease Payments Receivable. Lease payments + Unguaranteed residual value Gross investment 50 25
2. Net Investment Net investment equals the gross investment plus any unamortized initial direct costs less the unearned income. The initial direct costs are amortized over the lease term by the effective interest method. + x Lease receivable Unguaranteed residual Gross investment PV Net investment 51 3. Unearned Interest Revenue This is the gross investment less the cost of the leased property p yplus any initial direct costs. It is amortized over the lease term by the effective interest method. Gross investment < Net investment > Unearned interest revenue Journal Entry: To record a direct financing lease DR Lease receivable (gross investment) $54,000 CR Unearned interest revenue (contra-lease receivable $18,661 CR Asset (at cost or FMV) (Cost + nonrecorded profit) 35,339 52 26
VI. Sale-Leaseback 53 A. Introduction In a sale-leaseback transaction, the owner of a property (seller-lessee) sells the property and simultaneously leases it back from the purchaser-lessor. Usually there is no visible interruption in the use of the property. Sale-leaseback transactions are treated as single financing transactions where, in general, any profit or loss is deferred and amortized. In general, two questions are involved in determining the treatment of any profits: 1. Is the lease a capital or operating lease? And 2. What portion of the rights to the leaseback property are retained? 54 27
B. Terminology 1. Selling Price Selling price is the negotiated t price in the saleleaseback agreement. It may be less than, equal to, or greater than the fair value of the property, depending on the negotiated terms of the sale-leaseback. 2. Profit or Loss on Sale Profit or loss on the sale is the amount which would have been recognized by the seller-lessee assuming there was no leaseback. It is calculated by subtracting book value from fair value (sale price). 55 3. Excess Profit on Sale-Leaseback a. Operating Lease Excess Profit The amount of profit on the sale which exceeds the present value of the minimum lease payments. Sale price < Asset NBV> Tentative ti gain < PV min. lease payments> Excess gain 56 28
b. Capital Lease Excess Profit The amount of profit on sale that exceeds the recorded amount of the asset. Note that this amount will be the same as in an operating lease unless the leaseback asset is recorded at the lower fair value. The recorded amount of the leaseback asset is the lesser of i. The fair value of the leased property, or ii. The present value of the minimum lease payments. 57 4. Rights to Remaining Use of Property Retained by Seller- Lessee The rights to the remaining use of the property are determined by the present value of rent payments paid by the seller-lessee. The seller-lessee's rights may be categorized as follows: a. "Substantially All" Rights Retained (Greater than 90%) The present value of the rent payments is equal to or greater than 90% of the fair value of the property. These leases are usually accounted for as capital leases. b. Rights Retained Are Less Than "Substantially All" but Greater than "Minor" (Between 90% - 10%) The present value of the rent payments is less than 90% of the fair value, but greater than 10% of the fair value of property at the lease inception. These leases are accounted for as either capital or operating leases, depending on the criteria. c. "Minor" Portion of Rights Retained by Seller-Lessee (Less than 10%) The present value of the rent payments is 10% or less of the fair value of the property at lease inception or the lease (back) period is 10% or less of the asset's remaining life. These leases are usually accounted for as operating leases. Note: To determine whether any sales-leaseback transaction should be accounted for as operating or capital, use the "OWNS" test. 58 29
Sale-Leaseback: Summary Gain Major Middle Minor 90% or More 90% 10% 10% or Less (Life or Sales Price) Defer All (Amortize over leaseback) Defer (up to PV of leaseback) (Amortize over leaseback) No Deferral Loss (NBV > FMV) (real economic losses) Recognize Immediately Recognize Immediately Recognize Immediately Other Losses (artificial loss) Defer All (Amortize over leaseback) Defer All (Amortize over leaseback) Recognize Immediately 59 EXAMPLE Leaseback Less Than "Substantially All" but More Than "Minor" On January 1, Year 1, Carlson Company sold an airplane with an estimated useful life of ten years. Carlson simultaneously leased back the airplane for three years. The lease is classified as an operating lease. Applicable data follow: Sale price, fair value $500,000 Book value of airplane 100,000 Monthly rental 5,100 Present value of lease rentals 153,000 Calculate the amount of Carlson s profit recognized on January 1, Year 1, and rent expense on December 31, Year 1. 60 30
EXAMPLE (continued) The present value of lease rentals exceeds 10% of the fair value ($50,000) but is less than 90% of the fair market value ($450,000). 000) Therefore, the amount of profit recognized is the amount in excess of the present value of the minimum lease payments. The calculation follows: Sale price $500,000 Less book value (100,000) Total profit 400,000 Less present value of lease payments (deferred amount) (153,000) Profit recognized at lease inception 1/1/Yr 1 (excess profit on sale leaseback) $247,000 Carlson s rent expense for the year is calculated as follows: Annual rent payments ($5,100 x 12 months) $ 61,200 Less one year recognition of deferred profit ($153,000 3 years) (51,000) Rent expense 12/31/Yr 1 $ 10,200 61 Developments in Lease Accounting FASB Proposed ASU 62 31
SEC Staff Report to Congress I. July 2005 SEC Staff Issued Report to Congress A. Required under 401 (c) of Sarbanes-Oxley Act B. The extent of Off-Balance Sheet Arrangements C. Whether current financial statements transparently reflect the economics of offbalance sheet arrangements D. Among many topics, Lease Accounting is discussed 63 Improving Financial Transparency Objectives-Oriented Standards II. SEC recommends: Accounting standards that are principle-based or "objectives-oriented": Clearly state the accounting objective Minimize the use of exceptions in a standard Avoid use of percentage tests ("bright lines") to evade intent Based on an approved and consistently applied conceptual framework Provide sufficient detail and structure to operationalize and consistently apply III. Rules-based standards: "further a need and demand for voluminously detailed implementation guidance creating complexity and uncertainty in the standard." 64 32
SEC Standard Setting Recommendations Leases IV. Reconsider A. Repeatedly identified as an area to be reexamined by the FASB. B. Current "all or nothing" approach not designed to reflect the wide variety of lease structures. C. Transparency and consistency in reporting is not achieved. D. A project on lease accounting would be consistent with several of the key initiatives identified in achieving transparency in reporting. 65 SEC Standard Setting Recommendations Leases Reconsider (continued) E. Currently uses "bright-lines" 1. Increases potential for similar arrangements to be portrayed differently F. Bright-line tests facilitate structuring leases by form over substance 1. Seek desired accounting treatment vs. principle-based approach 66 33
SEC Standard Setting Recommendations Leases V. The lease project is complex and controversial VI. Leases have many different terms including: contingent rents optional extensions penalty clauses purchase options 67 Developments in Lease Accounting FASB Proposed ASU 68 34
Proposed FASB ASU on Leases Developments in Lease Accounting FASB Proposed ASU General Provisions of Lease Accounting Lessee Accounting Lessor Accounting Other Lease Accounting Topics Effects on Financial Reporting Transition and Effective Date 69 Leases General Provisions I. Corporate Behavior Why Enter into a Lease? A. Avoid large initial cash outlays B. Features and options offered by lessor C. Financial flexibility D. Off-balance sheet financing E. Tax Advantages of capital lease deductions for: 1. Depreciation 2. Interest Expense 3. Synthetic Leases F. Start-up company may lack credit to borrow from bank G. Restaurants and Retailers: 1. No need for lease vs. buy decision (shopping malls) 2. Embedded in business model 3. Prime Location 70 35
Leases 2010 Exposure Draft II. Leases 2010 Exposure Draft A. On August 17, 2010, the ISAB and the FASB issued an exposure draft on Leases that proposes p that a new standard on lease accounting for lessees and that lessors would replace IAS 17 Leases, IFRC 4 Determining whether an arrangement contains a Lease, SIC- 15 Operating Leases Incentives, and SIC-27 Evaluating the Substance of Transactions Involving the Legal Form of a Lease. Source: Aug. 2010 Exposure Draft 71 Leases General Provision III. IV. Definition A. Lease a contract in which the right to use a specified asset is conveyed, for a period of time, in exchange for consideration. Scope A. The proposed standard will apply to all leases including subleases of right-to-use assets. Some arrangements that are specifically stated to not be within the scope of the exposure draft are: 1. Leases of intangible assets 2. Leases to explore for or use minerals, oil, natural gas, and other nonregenerative resources; 3. Leases of biological assets; and 4. Leases that meet the definition of onerous contracts prior to the date of the commencement of the lease. 5. Contracts that represent the purchase or sale of the underlying asset would be excluded from the scope. A contract constitutes a purchase or a sale if, at the end of the contract, the contract transfers both of the following: a. Control of the underlying asset. b. All but a trivial amount of the risk and benefits associated with the underlying asset. 72 36
Leases General Provision IV. Scope B. Includes: 1. Combined services and lease contracts (bifurcate lease) 2. Short term leases 3. Sale-leasebacks 4. Subleases 5. Leveraged leases (tentatively added at the July 13, 2011 meeting) C. Excludes immaterial items. 1. If material in the aggregate, consider a policy similar to PP&E capitalization policy. 72 Leases 2010 Exposure Draft. KEY POINT DEFINITION OF A LEASE AS UPDATED BY THE BOARDS ON APRIL 12, 2011 1. An entity would determine whether a contract contains a lease by assessing whether: a. The fulfillment of the contract depends on the use of a specified asset; and b. The contract conveys the right to control the use of a specified asset for a period of time. 2. A contract would convey that right to control the use if the customer has the ability to direct the use, and receive the benefit from use, of a specified asset throughout the lease term. Guidance on separating the use of a specified asset from other services should be aligned with the boards tentative decisions in March 2011 relating to the separation of lease and non-lease components. 3. A specified asset refers to an asset that is explicitly or implicitly identifiable. 4. A physically distinct portion of a larger asset of which a customer has exclusive use is a specified asset. A capacity portion of a larger asset that is not physically distinct (for example, a capacity portion of a pipeline) is not a specified asset. 74lese 37
Leases 2010 Exposure Draft. KEY POINT Topics pending Board decision i on whether they will be included d in scope: 1. Leases of internal-use software in accordance with Subtopic 350-40, Intangibles Goodwill and Other Internal-Use Software, of the FASB Accounting Standards Codification. 2. Leases of inventory. 74 Leases General Provision V. Types of Leases A. At the Feb 17 th meeting the boards tentatively decided to identify a principle for identifying two types of leases for both lessees and lessors, with different profit and loss effects, as follows: 1. A finance lease with a profit or loss recognition pattern consistent with the proposals in the exposure draft. 2. An other-than-finance lease with a profit or loss recognition pattern consistent with an operating lease under existing IFRSs/U.S. GAAP. B. The boards tentatively decided to establish indicators to distinguish a finance lease from an other-than-finance lease C. The boards asked the staff to use these tentative decisions to perform targeted outreach to determine if stakeholders concerns about the profit and loss recognition pattern proposed in the exposure draft would be addressed. D. To date no subsequent decisions on this topic have been noted. 72 38
Leases General Provision KEY POINT Ownership transfers at end of lease (upon final payment or required buyout) Written option for bargain purchase Ninety (90%) percent of leased property F.V. <= P.V. of lease payments Seventy-five (75%) percent of asset economic life is being committed in lease term Operating Leases 73 Leases 2010 Exposure Draft Note: A contract would normally meet both of these criteria when it transfers title of the underlying asset automatically at the end of the contract or includes a bargain purchase option in which it is reasonably certain, at the inception of the lease, that the lessee will exercise the option. But, all facts and circumstances should be considered, not just how the transaction is described in the contract. KEY POINT The determination about whether a contract is a purchase or sale is made at the time of inception and is not subsequently reassessed. Transfer of the title of the asset alone is insufficient i for an entity to decide that the transaction should be treated as a purchase or sale. For purchase or sale treatment, all but a trivial amount of the risks and benefits must also be transferred to the lessee. 74 39
Developments in Lease Accounting FASB Proposed ASU General Provisions of Lease Accounting Lessee Accounting Lessor Accounting Other Lease Accounting Topics Effects on Financial Reporting Transition and Effective Date 75 Lessee Accounting - General General A lessee s s rights and obligations under all leases, existing and new, would be recognized on the balance sheet. Removes the concept of capital leases and operating lease classifications. Straight-line rent expense will be replaced with amortization of the right-of-use asset and interest expense on the lease obligation Lessee Recognizes on Balance Sheet Right-of- Liability to use Asset make Lease Payments Amortization Expense Income Statement Interest Expense 76 40
Lessee Accounting Initial Measurement I. Initial Measurement A. Initially recognize asset and liability at present value of lease payments to be made. B. The right-of-use asset is measured at the amount of the lease obligations plus any initial direct costs incurred. 1. Initial direct costs: Incremental costs directly attributable to negotiating and arranging the lease that would not have been incurred had the lease transaction not been made (commissions, legal fees). C. Present value uses the rate charged by lessor if available or lessee s incremental borrowing rate. D. It also includes: 1. Options (renewal and termination) in lease term 2. Contingent rentals, residual value guarantees and termination payments 77 Lessee Accounting Initial Measurement E. Measurement Date 1. The initial measurement of the lease asset and liability as well as the date to determine the discount rate is to be the commencement date of the lease rather than the inception date. a) Inception of the lease is the earlier of the date of the lease agreement and the date of commitment by the parties to the principal provisions of the lease. b) Commencement of the lease term is the date from which the lessee is entitled to exercise its right to use the leased asset. 2. The lease standard will also include guidance regarding: a) The treatment of costs incurred between the inception and commencement dates. b) Lease payments made prior to the commencement date. 77 41
Lessee Accounting Lease Term II. Lease Term A. The lease term is now the same for lessee and lessor. It is defined as the non-cancellable period for which the lessee has contracted with the lessor to lease the underlying asset, together with any options to extend or terminate the lease when there is a significant economic incentive for an entity to exercise an option to extend the lease, or for an entity not to exercise an option to terminate the lease Lessees would be required to estimate the ultimate expected lease term and periodically reassess such estimate. B. The boards are to publish indicators of what defines a clear economic incentive. C. The lease term will be reassessed by both parties only when there is a significant change in relevant factors such that the lessee would then either have, or no longer have, a significant economic incentive to exercise any options to extend or terminate the lease. 78 Lessee Accounting Lease Payments III. Lease Payments A. Concept of minimum lease payments is gone. B. Lease payments will include contractual t payments plus estimated t contingent rentals. 1. Percentage rent. 2. Payments which depend on an index or rate updated at the July 20 meeting. a. Initial measurement at date of commencement of lease. b. Reassess at the rate in effect at the end of each reporting period. c. Reflect any adjustment in the income statement if it applies to the current period or to the value of the right-to-use asset if they relate to a future period. 85 42
Lessee Accounting Lease Payments IV. Lease Payments 3. Termination penalties should be consistent with the accounting for options to extend or terminate a lease. 4. Guaranteed residual values except for amount guaranteed by unrelated third parties. 85 Lessee Accounting Lease Payments C. Contingent Rentals and Residual Value Guarantees 1. The exposure draft provides that contingent rentals and residual value guarantees a must be estimated and accounted for using an expected outcome approach, based on a probability-weighted average for a reasonable number of potential outcomes. Contingent rentals based on interest rate changes would be estimated using spot rates. a. Amounts payable under purchase options would be excluded from the present value of lease payments calculation. 86 43
Lessee Accounting Lease Payments b. When determining the present value of lease payments, the lessee must include contingent rents, residual value guarantees, and expected payments under termination penalties. KEY POINT This represents a major change from the current lease accounting guidance under GAAP and IAS that call for the exclusion of contingent rents from the minimum lease payment calculation regardless of their probability of occurrence. 2. Initial Measurement: The underlying asset would be initially measured at the amount of the liability and adjusted for any prepaid lease rentals and any recoverable initial direct costs that the lessee incurs. 87 Lessee Accounting Lease Payments 3. Timing of Recognition: The asset and liability would be measured at the inception of the lease, but neither would be recognized until the date that the lessor makes the underlying asset available to the lessee for use. KEY POINT Under the exposure draft, contingent rents are required to be estimated and included in the minimum lease payment calculation that is recorded at the commencement of the lease. The current guidance under GAAP calls for the exclusion of contingent rents from the minimum calculation regardless of their probability of occurrence. 88 44
Lessee Accounting Subsequent Measurement V. Subsequent Measurement A. Reassess the carrying amount of the lease payment obligation if there is a significant change B. Accounting for Subsequent Measurement 1. Changes in lease terms: Adjust the right-of-use asset and the obligation to make rental payments 2. Changes to assumptions (contingent rents, GRV and termination penalties): Reflected in earnings if change arises from current or prior reporting periods 3. Changes related to future reporting periods: Adjust the right-ofuse asset and the obligation to make rental payments KEY POINT No changes required for the incremental borrowing rate. The discount rate is locked in at initial measurement 89 Lessee Accounting Financial Reporting VI. Presentation A. Balance Sheet 1. Right of use assets presented with PP&E but separate from non- lease assets. a. Amortization term of LHIs to coincide with lease term. 2. Lease obligation presented separate from other liabilities. a. Could affect leverage covenants. B. Income Statement 1. Straight-line expense replaced with amortization and interest expense. 2. Foreign exchange differences related to the liability to make lease payments. C. Statement of Cash Flows 1. Cash payments shown as financing activity. 90 45
Lessee Accounting Financial Reporting D. Updated Requirements Tentative Decisions as of July 21, 2011 1. Statement of Financial Position - Lessees may separately present or disclose the values related to right of use assets and liabilities. a. If they do not separately present they must disclose in what account the values are included. b. The right of use assets should be presented as if they are owned assets. 90 Lessee Accounting Financial Reporting 2. Statement of Cash Flows: a. Cash paid for leases payments is classified in financing activities. t b. Classify or disclose the cash paid relating to interest using U.S. GAAP or IFRS. c. Classify cash paid for variable lease payments not included in the measurement of the liability to make lease payments as operating activities. (FASB: 4 to 3; IASB: 13 IASB to 2). d. Cash paid for short-term leases not included in the lease liability value are treated as operating activities. 90 46
Lessee Accounting Financial Reporting 91 Lessee Accounting Financial Reporting 92 47
Lessee Accounting Financial Reporting VII. Disclosure A. As of the July 21 st meeting the boards tentatively decided on the following disclosure requirements: 1. A reconciliation of the opening and closing balance of right-of-use assets, disaggregated by class of underlying asset. 2. A reconciliation of the opening and closing balance of the liability to make lease payments disaggregation is not required as it was in the ED. 3. Maturity analysis of the undiscounted cash flows that are included in the liability to make lease payments. The maturity analysis should show, at a minimum, the undiscounted cash flows to be paid in each of the first five years after the reporting date and a total of the amounts for the years thereafter. The analysis should reconcile to the liability to make lease payments. 90 Lessee Accounting Financial Reporting 4. Information about the principal terms of any lease that has not yet commenced if the lease creates significant rights and obligations for the lessee. 5. Information required in paragraphs 73(a)(ii)-73(a)(iii) of the exposure draft (additional guidance pending on this item.) 6. All expenses relating to leases recognized in the reporting period, in a tabular format, disaggregated into (a) amortization expense, (b) interest expense, (c) expense relating to variable lease payments not included in the liability to make lease payments, and (d) expense for those leases for which the short-term practical expedient is elected, to be followed by the principal and interest paid on the liability to make lease payments. 90 48
Lessee Accounting Financial Reporting 7. Qualitative information to indicate if circumstances or expectations about short-term lease arrangements are present that would result in a material change to the expense in the next reporting period as compared with the current reporting period B. Tentatively the boards agreed these items do not require disclosure: 1. The discount rate and range of discount rates used to calculate the liabilities to make lease payments. 2. The fair value of the liability to make lease payments. 3. The existence and principal terms of any options to purchase the underlying asset, or initial direct costs incurred on a lease. 4. Information about arrangements that are no longer determined to contain a lease. 90 Lessee Accounting Financial Reporting C. Future Commitments The 2 Boards Differ on This Point. 1. FASB: lessee should disclose the future contractual commitments associated with services and other non-lease components that are separated from a lease contract. 2. IASB: lessee is not required to disclose the future contractual commitments associated with services and other non-lease components that are separated from a lease contract. 90 49
Developments in Lease Accounting FASB Proposed ASU General Provisions of Lease Accounting Lessee Accounting Lessor Accounting Other Lease Accounting Topics Effects on Financial Reporting Transition and Effective Date 94 Lessor Accounting General I. Dual Model A. Performance Obligation Approach 1. Lease receivable and liability to permit lessee s use of asset 2. Interest income and lease income as obligation is satisfied B. De-recognition Approach 1. Used only if lessor does not retain significant risks and rewards of ownership of leased asset 2. Up-front gain for de-recognition of leased asset KEY POINT Ownership transfers at end of lease (upon final payment or required buyout) Written option for bargain purchase Ninety (90%) percent of leased property F.V. <= P.V. of lease payments Seventy-five (75%) percent of asset economic life is being committed in lease term Operating Leases 95 50
Lessor Accounting General II. Estimates for Both A. Lease term, contingent payments, other assumptions similar to lessee accounting. B. Predict lessee s behavior as to whether or not lessee is likely to exercise the options built into the lease 96 Lessor Accounting General 97 51
Lessor Accounting General III. Performance Obligation Approach KEY POINT Ownership p transfers at end of lease (upon final payment or required buyout) Written option for bargain purchase Ninety (90%) percent of leased property F.V. <= P.V. of lease payments Seventy-five (75%) percent of asset economic life is being committed in lease term Operating Leases A. When risks and benefits of underlying asset are retained, lessor considers: 1. Significance of contingent rentals during the expected lease term based on performance or use of the underlying asset, 2. Options to extend or terminate the lease, or 3. Material non-distinct services provided in the lease contract. 98 Lessor Accounting General B. The underlying leased asset remains on the lessor s balance sheet. C. The lessor recognizes: es 1. A lease receivable (right to receive rental payments from the lessee). 2. A corresponding performance obligation / lease obligation. D. As the performance obligation is satisfied, revenue is recognized. 99 52
Lessor Accounting General E. Subsequent measurement: Performance obligation approach Subsequent measurement of the lessor s receivable would be at amortized cost using the effective interest method, resulting in interest income. 1. The exposure draft proposes that, from the time that the lease is commenced, the lessor would measure its lease asset at amortized cost using the effective interest method and recognize any impairments in accordance with IAS 39 Financial Instruments: Recognition and Measurements. a) The right to receive lease payments is amortized over the life of the lease, and the lessor recognizes interest income using the interest method. b) To amortize the performance obligation, the lessor must use a rational and systematic approach based on pattern of use. If none exists, straight-line amortization should be used. 100 Lessor Accounting General F. Reassessment: Performance Obligation Approach 1. The exposure draft requires the lessor to reassess the amount of expected lease payments, the lease term, contingent rentals, termination options, and residual value guarantees each reporting period if the facts or circumstances indicate that a significant change in the right to receive rental payments has occurred. 2. Accounting for Changes a) Changes to lease term: Adjust the lease liability and the right to receive lease payments. b) For contingent cash flows: 1) Recognize in revenue, if the performance obligation has been already satisfied 2) Recognize as an adjustment to performance obligation if obligation has not yet been satisfied 101 53
Lessor Accounting General G. Presentation: Performance Obligation Approach Performance Obligation Lessor Financial Statement Presentation Balance Sheet Underlying Asset xx Right to Receive Lease Payments xx Lease Liability (xx) Net Lease Asset / (Liability) xx Income Statement Lease Income xx Depreciation Expense (xx) Interest Income xx Source: August 2010, IASB Exposure Draft Snap Shot: Leases 102 Lessor Accounting General IV. Derecognition Approach: V. KEY POINT Ownership p transfers at end of lease (upon final payment or required buyout) Written option for bargain purchase Ninety (90%) percent of leased property F.V. <= P.V. of lease payments Seventy-five (75%) percent of asset economic life is being committed in lease term Operating Leases A. Assumes that the lessor has performed by delivering the leased asset and providing an unconditional right to use it over the lease term. B. The lessor recognizes: 1. A receivable (right to receive rental payments from the lessee) and 2. Records revenue 103 54
Lessor Accounting General C. A portion of the carrying value of the leased asset is viewed as having transferred to the lessee, is derecognized and recorded as cost of sales D. The amount derecognized: 1. Based on the relationship between the fair value of the receivable from the lessee and the fair value of the underlying asset 2. Determined at inception of the lease E. The lessor would not remeasure the residual asset retained, except for impairment. F. The value of the residual asset would not be accreted over time KEY POINT Note that, although the exposure draft would require the lessor to recognize income and expense at the time the lease is commenced, the amount of profit recognized initially may differ from that recognized under a sales-type lease under the current GAAP rules. This is because the guidance in the exposure draft differs from the current lease accounting guidance with regards to contingent rentals, residual value guarantees, and other elements of lease contracts. 104 Lessor Accounting General G. Subsequent Measurement: Derecognition Approach 1. The exposure draft proposes that, from the onset of the lease, the lessor would measure the leased asset at amortized cost using the effective interest method and recognize any impairment in accordance with the guidance set forth in IAS 39. 2. The lessor would reassess its lease liability similar to how the lessee would reassess its liability except that the lessor would: a) Allocate any change in the carrying amount of the leased asset that is attributable to a reassessment of the lease term between the residual asset and profit and loss; and b) Recognize other changes in the carrying amount of the leased asset in profit or loss. 105 55
Lessor Accounting General 3. The residual asset would not be remeasured unless there is a change in lease term or a subsequent impairment of the underlying asset. 4. Note: The lessor would apply the guidance set forth in ASC (IAS 39) as of each reporting date to determine whether its right to lease payments has been impaired, and it would apply the guidance in ASC 350 (IAS 36) to determine whether the residual asset has been impaired. Source: KPMG IFRS Briefing Sheet August 2010, Issue 205 and Deloitte, FASB Draws a Bright Line Through Operating Leases, Volume 17, Issue 27 106 Lessor Accounting Changes in Estimate and Remeasurement H. Reassessment: Derecognition Approach: 1. Reassessment resulting in a change in term - change in the lease receivable e is allocated to the rights derecognized ecog ed and the residual asset. 2. For contingent cash flows, changes in the lease receivable are adjusted through revenues. 107 56
Lessor Accounting Changes in Estimate and Remeasurement I. Presentation: Derecognition Approach: 1. The exposure draft provides that the lessor would present the leased asset separate from other financial assets and the residual asset separately within property, plant, and equipment in the statement of financial position. 2. Presentation in profit or loss would depend on the lessor s business model: a. If the lessor uses the leases for the purposes of financing, then net lease income and expense would be presented as a single line item; and b. If the lessor uses the leases as an alternative to selling the asset, then net lease income and expense would be presented as separate line items. I. Source: KPMG IFRS Briefing Sheet August 2010, Issue 205 and Deloitte, FASB Draws a Bright Line Through Operating Leases, Volume 17, Issue 27 108 Lessor Accounting Changes in Estimate and Remeasurement V. Current Status A. Lessor accounting is still in flux. The information presented here eereflects ectsthe eoriginal exposure posuedat draft. There eeis much ongoing deliberation on this topic including whether there should be 1 or 2 approaches to lessor accounting. Until such time as the boards agree on which approach it is beneficial to understand the original exposure draft and take note of the subsequent points here as to significant open issues. 107 57
Lessor Accounting Changes in Estimate and Remeasurement Current Status B. May 17, 2011 meeting 1. Discussed whether there should be one or two approaches to lessor accounting. This discussion is to be continued at a future meeting. 2. They will consider the implications from requiring lessees to use a single approach 3. They discussed a number of related topics and requested the staff to investigate further and report back. To date this meeting to review has not occurred. 4. They indicated a preference to treating leases like other financial instruments but requested the staff to investigate if this would have unintentional consequences if two approaches were selected for lessor accounting. 107 Leases 2010 Exposure Draft. KEY POINT If a single approach is used, the boards tentatively t ti decided d that: t 1. The lessor would derecognize a portion of the carrying amount of the underlying asset. (FASB: unanimous; IASB: 12 to 2). 2. The lessor would initially measure the residual asset as an allocation of the carrying amount of the underlying asset. (FASB: unanimous; IASB: unanimous). 3. The lessor would subsequently measure the residual asset by accreting the amount of the residual asset over the lease term, using the rate that the lessor charges the lessee. (FASB: 5 to 2; IASB: unanimous). 74 58
Lessor Accounting Changes in Estimate and Remeasurement V. Current Status C. The following issues were discussed at the June 14, 2011 meeting the boards. 1. The boards discussed a single approach to lessor accounting whereby the lessor would recognize a lease receivable and a residual asset at lease commencement. In subsequent meetings this is known as the receivable residual approach. 2. The boards will discuss at a future meeting whether and when, under such an approach, it is appropriate for a lessor to recognize profit at lease commencement. 3. The boards will also discuss at a future meeting whether there should be different lessor models for: a. a lease of a portion of an asset and b. a lease of an entire asset. 107 Lessor Accounting Changes in Estimate and Remeasurement D. Tentative decisions from the July 20, 2011 meeting on how to apply the Receivable-Residual Approach 1. Recognize the right to receive lease payments and a residual asset at commencement date. 2. Measure the right to receive lease payments at the sum of the present value of the lease payments, discounted using the rate the lessor charges the lessee. 3. Measure the residual asset as an allocation of the carrying amount of the underlying asset. Subsequently measure the residual asset by accreting it over the lease term using the rate the lessor charges the lessee. 107 59
Lessor Accounting Changes in Estimate and Remeasurement 4. If profit on the right-of-use asset transferred to the lessee is reasonably assured, recognize that profit at the date of the commencement of the lease. 5. If profit on the right-of-use asset transferred to the lessee is not reasonably assured, recognize that profit over the lease term. a) Residual Asset = Difference in carrying amount of the asset and the right to receive lease payments. Accrete the residual asset so at the end of the lease the value will be as it would have been if lessor had been depreciating the asset. 6. If the right to receive lease payments is greater than the carrying amount of the underlying asset at the date of the commencement, recognize, as a minimum, the difference between those two amounts as profit at that date. 107 Lessor Accounting Changes in Estimate and Remeasurement 7. Leases of investment property measured at fair value and short-term leases are excluded from the receivable-residual approach. a) Lessors will continue to depreciate those assets and recognize lease income systematically over the lease term. 8. Noted Open Issues: 1. Leases tied to an index presentation for the lessor. 107 60
Lessor Accounting Changes in Estimate and Remeasurement EXAMPLE Derecognition Lessor Financial Statement Presentation Balance Sheet Residual Asset xx Right to Receive Lease Payments xx Income Statement Revenue xx Cost of Goods Sold (xx) (gross or net based on business model) $ Interest Income xx Source: August 2010, IASB Exposure Draft Snap Shot: Leases 109 Developments in Lease Accounting FASB Proposed ASU General Provisions of Lease Accounting Lessee Accounting Lessor Accounting Other Lease Accounting Topics Effects on Financial Reporting Transition and Effective Date 111 61
Other Lease Accounting Issues I. Short-term Leases A. Lease terms 12 months or less (including renewals). B. Lessee and Lessor may elect to use the lease guidance, or C. Lessee may recognize lease payments in profit or loss on a straightline basis over the lease term. D. Lessor would not record in the statement of financial position. E. Required disclosures for this treatment are not yet finalized. 112 Other Lease Accounting Issues II. Sale-Leasebacks A. Update from March 22, 2011 Meeting 1. Boards affirmed the decision that when a sale has occurred, the transaction would be accounted for as a sale and then a leaseback. 2. Tentatively decided that an entity should apply the control criteria described in the revenue recognition project to determine whether a sale has occurred. 3. Affirmed that the seller/lessee would adopt the whole asset which deems that, the seller/lessee sells the entire underlying asset and leases back a right-of-use asset relating to part of the underlying asset. 113 62
Other Lease Accounting Issues 4. Tentatively decided that the leases guidance would not prescribe a particular type of lessee accounting model for entities that are accounting for the leaseback part of a sale and leaseback transaction. 5. Affirmed the decision that in a transaction accounted for as a sale and leaseback: a. When the consideration is at fair value, the gains and losses arising from the transaction should be recognized when the sale occurs. b. When the consideration is not established at fair value, the assets, liabilities, gains and losses recognized should be adjusted to reflect current market rentals. 113 Other Lease Accounting Issues III. Subleases A. Account for head lease and sub-lease as separate transactions. B. An intermediate lessor, as a lessee in a head lease arrangement, should account for its assets and liabilities arising from the head lease in accordance with the decisions-to-date for all lessees. (FASB: unanimous; IASB: unanimous). C. An intermediate lessor, as a lessor in a sublease arrangement, should account for its assets and liabilities arising from the sublease in accordance with the decisions-to-date for all lessors. (FASB: unanimous; IASB: unanimous) D. If the boards decide that there should be more than one approach to lessor accounting, an intermediate lessor, as a lessor in a sublease, should evaluate its right-of-use asset, not the underlying asset, to subleases. 114 63
Other Lease Accounting Issues Cash $ X Accounts Receivable X Property, Plant and Equipment X Right of use asset X Sublease receivables X Sublease liabilities (X) Net sublease assets X Total Assets $ X Accounts payable & accrued expenses $ X Liability to make lease payments X Total Liabilities $ X 114 Developments in Lease Accounting FASB Proposed ASU General Provisions of Lease Accounting Lessee Accounting Lessor Accounting Other Lease Accounting Topics Effects on Financial Reporting Transition and Effective Date 115 64
Lease Accounting Financial Reporting I. Balance Sheet A. Current pro-forma capitalizations of operating leases are likely to understate to amounts presented under the new lease model. Reported Assets are Higher Current & Non-current Liabilities are Higher Asset Turnover Ratio Return on Equity Debt-to to-equity Ratio Working Capital 116 Lease Accounting Financial Reporting II. Income Statement Lower rent expense partially offset by increased amortization Higher amortization expense and interest expense EBIT OM Earnings EPS Statement of Cash Flows Cash flows associated with leases are classified as financing activities Operating Cash Flow 117 65
Disclosures III. Disclose: A. Quantitative and qualitative information identifying and explaining amounts recognized ed in the financial a statements e ts arising from leases. B. Description of how leases affect the amount, timing and uncertainty of the company s future cash flows. C. The nature of the company s lease arrangements; and D. Information about the principal terms of any lease that has not yet commenced if the lease creates significant rights and obligations for the company. 118 Disclosures IV. Disclose: A. A reconciliation between the opening and closing balances of rightof-use assets and obligations o to pay rentals, disaggregated by class of underlying asset. B. A narrative disclosure of significant assumptions and judgments relating to renewal options, contingent cash flows, and the discount rate used. C. A maturity analysis of the gross obligation to pay rentals showing: 1. Undiscounted cash flows on an annual basis for the first five years and a total of the amounts for the remaining years and 2. Amounts attributable to the minimum amounts specified in the lease and the amounts recognized in the balance sheet 119 66
Disclosures V. Disclose: A. Under the performance obligation approach: 1. Lessors would classify collection of the lease receivable and interest income arising from that receivable as operating activities in the statement of cash flows. B. Additional disclosures would apply if: 1. The simplified option for short-term leases is elected, 2. Significant subleases exist, or 3. There is a sale-leaseback transaction 120 Disclosures Lessee - Reconciliation Roll-forward Disclosure Right-of-use Assets Balance at January 1, 20X0 1,000 Changes in estimates from: Liability to make Lease Payments $ $ (1,000) Options 50 (50) Contingent rentals 40 20 Residual value guarantees 10 (10) Subtotal for changes in estimates 100 (40) Revaluations (for IFRS) 25 - Additions for new right-of-use assets/ (obligations) 200 (200) 1,325 (1,240) Impairments (100) - Accumulated Amortization at January 1, 20X0 (400) - Amortization during year (40) - Accumulated Amortization at December 31, 20X0 (440) - Disposals of right-of-use assets/ (obligations) (30) 30 Repayments of obligations - 80 Balance at December 31, 20X0 $ 755 $ (1,130) Contractual Obligations Total Obligations 20X0 XX XX 20X1 XX XX 20X2 XX XX 20X3 XX XX 20X4 XX XX 20X5 and Thereafter XX XX Total $ XXX $ XXX 121 67
Developments in Lease Accounting FASB Proposed ASU General Provisions of Lease Accounting Lessee Accounting Lessor Accounting Other Lease Accounting Topics Effects on Financial Reporting Transition and Effective Date 122 Lease Accounting Transition and Effective Date I. Effective Date A. Not yet determined. B. Most likely 2013. C. Some believe it may be later. 123 68
Lease Accounting Transition and Effective Date II. Transition A. No grand-fathering B. Required to inventory all lease contracts and for each: 1. Determine the lease term and 2. Effect of contingent payments, GRVs, and termination payments C. Applied as of beginning of first comparative period presented. All lease contracts are effectively reset to year one of adoption of the final standard. D. Requires hindsight of assumptions. E. Uses simplified retrospective method. F. Consider leases expiring before effective date but part of comparative period G. Remove Deferred FASB Rent, Capital Lease Obligations & Assets H. Effect on net income can be significant because the model produces higher aggregate expense in early periods of a lease term I. Deferred Tax and Sales/ Use Tax Considerations 124 Lease Accounting Other Considerations 1. Valuations of Leases in M&A 2. Accounting for tenant incentives 3. IT systems for tracking 4. Controls over assumptions 5. When to re-measure assumptions 125 69
Lease Accounting General Update A. The boards to date have addressed a number of topics but there are still a number of topics under discussion including: 1. One or two approaches for lessor accounting 2. Disclosure on short term leases 125 Final Polling Question: Which is your preference? A. Questions. B. Comments. C. Just give me my CPE Certificate! Thank you! 126 70