Transcript Document

Proposed Accounting
Standards Update to
Lease Accounting
February 22, 2011
Presenters
Today’s presenters:
Paul Anderson, CPA
Director of Assurance
GBQ Partners LLC
[email protected]
614.947.5203
Jeff Alton, CPA
Assurance Manager
GBQ Partners LLC
[email protected]
614.947.5202
1
February 10, 2011
Overview
• The core principle is that lease contracts give rise to assets and liabilities that should be
reflected in the balance sheets of lessees and lessors.
• All lessees would use a single method of accounting for all leases.
• The accounting by a lessor would reflect its exposure to the risks or benefits of the
underlying leased asset.
• Users of financial statements would have more timely information about variable features
such as renewal options and contingent rentals.
• A simplified approach would apply to short-term leases.
• The proposal does not change the current definition of a lease contract.
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February 10, 2011
Proposed Accounting Standards Update: Leases
(Topic 840)
• Released August 2010/Joint project with IASB
• Significant change to existing lease accounting model
• Would impact both lessees and lessors
• Eliminates off-balance sheet (i.e., operating) leases
• Retrospective application on adoption, thus no grandfathering of existing leases is
expected
• Comment period ended: December 15, 2010
• Final standard issuance: June 2011 (expected)
• Effective date: ?
3
February 10, 2011
Key Term Definitions
Term
Abbreviation
Definition
Contingent rentals
CR
Lease payments that arise under the contractual terms of a lease because of
changes in facts or circumstances occurring after the date of inception of the
lease, other than the passage of time.
Date of
commencement of
the lease
DCL
The date on which the lessor makes the underlying asset available for use by
the lessee.
Date of inception of
the lease
DIL
The earlier of the date of the lease agreement and the date of commitment
by the parties to the lease agreement.
Initial direct costs
IDC
Recoverable costs that are directly attributable to negotiating and arranging
a lease that would not have been incurred had the lease transaction not been
made.
Lease
Lease
A contract in which the right to use a specified asset is conveyed, for a
period of time, in exchange for consideration.
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February 10, 2011
Key Term Definitions (continued)
Term
Abbreviation
Definition
Lease liability
LL
The lessor’s obligation to permit the lessee to use the underlying asset over the
lease term.
Lease
payments
LP
Payments arising under a lease including fixed rentals and rentals subject to
uncertainty, including, but not limited to, contingent rentals and amounts
payable by the lessee under residual value guarantees.
Lease term
LT
The longest possible term that is more likely than not to occur.
Residual asset
RA
An asset representing the rights to the underlying asset retained by the lessor
under the derecognition approach for lessor accounting
Residual value
guarantee
RVG
A guarantee made by the lessee that the fair value of the underlying asset that
the lessee will return to the lessor will be at least a specified amount. If the fair
value is less than that amount, the lessee is obliged to pay the difference to the
lessor.
Right-of-use
asset
ROU asset
An asset the represents the lessee’s right to use, or control the use of, a
specified asset for the lease term.
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February 10, 2011
Scope
•
Applies to all entities
•
Includes leases of property, plant, and equipment
•
Excludes:
•

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
Leases of intangible assets

Leases to explore for or use natural resources (i.e., minerals, oil and gas)

Leases of biological assets

Contracts that represent the purchase or sale of the underlying asset
Includes contracts with both service and lease components, with certain exceptions
Most contracts viewed as leases under current GAAP will be subject to the new guidance
February 10, 2011
Lessee Accounting Model - Recognition
•
•
Right-of-use (“ROU”) approach

Right to use an asset for a specified period of time

Gives rise to both an asset and a liability
Asset = right to use item for lease term

•
Liability = obligation to pay rentals


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Recognized and carried at amortized cost
Present value of payments
One accounting model replaces current two model approach (capital and operating
leases)
February 10, 2011
Lessee Accounting Model - Recognition
8
•
Right of use asset and liability recognized on statement of financial position on date of
commencement of lease (“DCL”)
•
The following will be subsequently recognized in the income statement:

Interest expense on the liability

Amortization expense of the asset

Changes in the liability resulting from reassessment of contingent rentals, residual
value guarantee, or term option penalties

Any impairment losses on the right of use asset
February 10, 2011
Measurement of Asset and Liability
•
Initially done as of date of inception of lease
•
Present value of lease payments

•
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Discounted at either:

Lessee’s incremental borrowing rate, or

Rate charged by lessor, if known
At inception, asset will be the same as the liability plus any initial direct costs, such as:

Commissions

Legal fees

Costs incurred in evaluating lessee, guarantees, and collateral

Closing costs

Note: the following costs are not considered initial direct costs: general overhead
expense, advertising or soliciting expense, costs associated with servicing an
existing lease.
February 10, 2011
Measurement - Lease Term
•
“Longest possible term that is more likely than not to occur”
•
Include optional renewal periods that are more likely than not to be exercised
 Different than “old’ accounting where optional renewal periods were ignored
•
•
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Continually reassessed based on significant changes

Renewal periods and early termination options

Estimates adjusted in period that facts and circumstances change
Assessment should consider both contractual and non-contractual factors
February 10, 2011
Example - Lease Term
•
Non-cancellable 10-year term
•
Option to renew for 5 years at the end of 10 years and an option to renew for an additional
5 years at the end of 15 years
•
The lessee estimates the probability for each term as follows: 40% for 10-year term, 30%
for 15-year term and 30% for 20-year term
•
Under these scenarios, the term would be at least 10 years, with a 60% chance that the
term would be 15 years or longer, but only a 30% chance that the term would be 20
years. Therefore, there is a 60% chance that the term would be 15 years, which is the
longest possible term more likely than not to occur. As such, the lease term would be 15
years.
This example is adapted from Paragraph B17 of the Exposure Draft.
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February 10, 2011
Measurement - Lease Payments
•
Initially used to measure asset and liability
•
“Expected outcome approach”

Present value of the probability-weighted average of the cash flows for a reasonable
number of outcomes

Estimating expected outcome involves:
a. Identifying each reasonably possible outcome. An entity need not assess every
possible outcome to identify the reasonably possible outcomes included in the
expected PV of the cash flows.
b. Estimating the amount and timing of the cash flows for each reasonably possible
outcome
c. Determining the present value of those cash flows
d. Estimating the probability of each outcome
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•
Include contingent amounts
•
Continually reassess
February 10, 2011
Expected Outcome Approach – Contingent Rents
Example
The Facts: A retailer enters into a 5 year lease which, in addition to fixed monthly payments, calls
for contingent rents to be paid at a rate of 1% of annual sales in excess of $1M. Contingent rents
are to be paid at the end of each year of the lease. Based on past performance and future
projections, management prepares the following analysis related to estimated forecasted sales.
The retailer’s incremental borrowing rate is 10%. As a result of the foregoing analysis, the retailer
would include contingent rent of $39,221 in its estimate of lease payments. The present value of
estimated yearly payments is $7,844 ($39,221/5).
Estimated Annual Sales
< $1.0 million
Probability
Estimated
Present
Probability
Contingent Rent
Value
Weighted
0%
-
$1.0 M to $1.5 M
25%
25,000
19,611
4,903
$1.5 M to $2.0 M
50%
50,000
39,221
19,611
$2.0 M to $2.5 M
25%
75,000
58,832
14,708
0%
-
$2.5 M >
150,000
-
-
-
117,664
Probability weighted outcome
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-
39,222
February 10, 2011
Expected Outcome Approach – Contingent Rents
Example (Continued)
Carrying on with the example on the previous slide, assume fixed monthly payments of
$5,000. Further assume the retailer incurred $20,000 in initial direct costs. The present
value of the lease payments, including the contingent rent determined above, is $274,548.
The recognized right of use asset at lease inception is $294,548; the lease liability is
$274,548. Assume actual sales in Year 1 were $2M; contingent rent due is $10,000.
•
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During the first year of the lease, the retailer will record the following:

Amortization of the right of use asset of $58,910 ($294,548/5)

Interest expense on the lease liability of $25,450 (based on a lease amortization
schedule using interest method)

Reduction of the lease liability for cash payments of $70,000 ($60,000 + $10,000)

Additional expense of $2,156 would need to also be recorded to "true up"
contingent rent ($10,000 - $7,844)

Effect in first year of lease of adopting the exposure draft:

Revised (ED) accounting model  total expense of $86,516 ($58,910 + $25,450 +
$2,156)

Current accounting model  total expense of $74,000 ($60,000 + $4,000 +
$10,000)
February 10, 2011
Subsequent Measurement
•
•
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Right of Use Asset:

Amortized on a systematic basis over the shorter of the lease term or useful life of
the underlying asset

Subject to impairment analysis under ASC 350
Liability:

Amortized cost using the using the interest method

Subject to periodic reassessments “…if facts or circumstances indicate that there
would be a significant change”

Discount rate is not reassessed unless specifically based on an index
February 10, 2011
Presentation
•
•
Right of use asset:

Presented as a tangible asset within PP&E

Segregated from non-leased assets
Liability:

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Separately from other financial liabilities
•
Interest and amortization expense presented separately from other interest/amortization
expense (either on P&L or in the footnotes)
•
Principal and interest cash payments will be a financing activity in the Statement of Cash
Flows
February 10, 2011
Recognition/Presentation – Financial Statement
Impact
•
Income Statement


•
Current GAAP

Rent expense classification

Included in Operating Income/Loss
Proposed GAAP

Interest and amortization expense classification; no rent expense

Amortization expense included in Operating Income/Loss; Interest excluded
Statement of Financial Position

The addition of lease liability on the balance sheet may impact debt ratios and
possibly covenant calculations
Note: Change in classification may impact EBITDA
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February 10, 2011
Lessor Accounting Model - Recognition
•
•
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Dual model approach

Performance obligation or

Derecognition
Centers on whether significant risks or benefits of the leased asset are retained

Exposure to risk/benefits can occur during and after the lease term

If retained = performance obligation model

If transferred = derecognition
•
Model determined at Date of Inception and not reassessed
•
Both models require estimates of lease term and contingent rentals
February 10, 2011
Recognition – Performance Obligation Approach
•
Underlying asset stays on the lessor’s books
•
As of date of commencement of the lease, lessor will recognize:
•

Asset for the right to receive lease payments

Liability at the present value of the lease payments
Subsequently, lessor will recognize:

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Interest income on right to receive lease payments

Lease income as lease liability is satisfied

Changes in lease liability resulting from reassessment of contingent rentals,
residual value guarantee or term option penalties

Potential for impairment losses on right to receive lease payments
February 10, 2011
Measurement – Performance Obligation Approach
•
Lease liability measured as the sum of the PV of lease payments, discounted using the rate
lessor charges the lessee
•
Right to receive asset measured as the sum of lease liability and any initial direct costs

Initial measurement based on longest possible lease term that is more likely than not
to occur

Measured at date of inception of the lease

Expected outcome approach

PV of the probability-weighted average of the cash flows for a reasonable
number of outcomes
 Asymmetrical amounts for lessor/lessee are probable
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February 10, 2011
Subsequent Measurement – Performance
Obligation Approach
• Right to receive asset is carried at amortized cost using the interest method

Subject to impairment testing under ASC 310-10 (loan impairment)
• Remaining lease liability measured based on pattern of use of the underlying asset by the
lessee, if pattern can be reliably determined using either inputs or outputs

If not reliably determinable, use straight-line method
• Underlying asset is depreciated over its expected useful life
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
Systematic and rational approach

If none based on pattern of use, straight-line method should be used

Asset subject to ASC 360 impairment testing (long lived assets impairment)
Recognition - Derecognition Approach
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•
Apply if performance obligation criteria not met
•
As of date of commencement of lease, lessor will:

Recognize a receivable for the right to receive rental payments with the offset to lease
income

Remove portion of the carrying amount of underlying leased asset from books which
represents the lessee’s right to use the asset during the lease term

Residual asset for the portion of the carrying amount of the leased asset that
represents the lessor’s non-transferred rights in that asset

Portion of the carrying value of leased asset removed from balance sheet and
recorded as cost of sale
February 10, 2011
Recognition - Derecognition Approach
Recognized in the income statement:
•
Lease income = PV of lease payments
•
Lease expense = cost of underlying asset derecognized
•
Interest income on right to return asset
•
Lease impact of any reassessments in right to return asset due to change in estimates of
contingent amounts
•
Impairment losses on right to return asset
 If lessor’s ongoing, major, or central activities involve leasing activities, lease income is
reported as revenue and lease expense as cost of revenue
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February 10, 2011
Measurement - Derecognition Approach
Allocation:
•
•
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Amount to be derecognized computed as:

(FV of right to receive lease payments/FV of the underlying leased asset) X Carrying
amount of the underlying leased asset

Residual asset is computed as the remaining amount of the carrying amount of the
underlying leased asset
Reassess when facts and circumstances indicate that there could be a significant change
February 10, 2011
Subsequent Measurement - Derecognition Approach
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•
Right to receive asset at amortized using interest method
•
No remeasurement of residual asset unless:

Terms change

Asset is impaired
•
ASC 310 used to assess impairment of right to receive asset
•
ASC 350 or 360 used to assess impairment of residual asset
February 10, 2011
Lessor Accounting Model - Presentation
Financial
Statement
Performance Obligation Approach
Derecognition Approach
Statement of
Financial
Position
• Present the following gross, totaling to a net
lease asset or liability
• Underlying asset
• Right to receive asset
• Lease liability
• Right to receive asset separately from other
financial assets
• Residual asset, separately within PP&E
Income
Statement
Interest income, lease income, and
depreciation presented gross, totaling to a net
lease income or expense amount
• Lease income and expense will be gross or
net depending on the nature of the lessor’s
business
• Separate interest income from RTR asset
from other interest income
Statement of
Cash Flows
• Cash received from lease payments treated
as operating activities
• Present separately from changes in other
operating receivables
Cash received from lease payments treated as
operating cash flow, separate from changes in
other operating receivables
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February 10, 2011
Disclosure – Lessors and Lessees
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•
Quantitative and qualitative information relative to lease arrangements
•
User should be able to understand amount and timing of expected cash flows;
disaggregation of information to the appropriate level
•
Significant NEW disclosure requirements:

Reconciliation of opening and closing balances of right-of-use assets and liabilities to
make lease payments, disaggregated by class of underlying asset

Narrative disclosure about the options that were recognized as part of the right-ofuse asset and those that were not

Assumptions and judgments relating to amortization methods and changes to those
assumptions and judgments

Initial direct costs incurred during the reporting period and included in the
measurement of the right-of-use asset or right to receive lease payments

Basis and terms on which contingent rentals are determined
February 10, 2011
Income Tax Considerations
•
•
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New model will create temporary differences

Assets/liabilities created for book purposes not reflected for tax purposes

ASC 740 requires gross basis recognition – no offsetting of deferred tax asset and
deferred tax liability arising from lease items
State and local taxes may be impacted
February 10, 2011
Short Term Leases
•
Maximum possible term (including all extension options) of 12 months or less
•
Lessee measurement:

At date of inception of lease, accounting election on a lease-by-lease basis:
1. Measure similarly to long term lease; or
2. Measure using simplified approach
•

Right of use asset and liability equal to undiscounted lease payments

Lease payment recognized in income statement over lease term
Lessor measurement:

At date of inception of lease, accounting election on a lease-by-lease basis:
1. Measure similarly to long term lease; or
2. Measure using simplified approach
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
No recognition of right-to-receive asset and lease liability; no derecognition
of underlying asset

Lease payments recognized in income statement over lease term
February 10, 2011
Short Term Leases
Simplified Approach – Example
The Facts: A lessee enters into a 12 month lease for storage space; the lease requires
monthly payments of $1,000. The lessee elects to account for the lease using the simplified
approach. Based on the fact pattern, the lessee would record the following entries:
Debit
Credit
At date of inception of lease:
Right of Use Asset
12,000
Lease Liability
12,000
To record asset and liability arising from the storage space lease.
Each of the subsequent 12 months:
Amortization Expense
1,000
Lease Liability
1,000
Right of Use Asset
1,000
Cash
1,000
To record cash paid and expense arising from the storage space lease.
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February 10, 2011
Adoption/Transition
•
All outstanding leases as of the date of initial application will be subject to the new
accounting
 No grandfathering of leases in existence as of the adoption date
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•
Date of initial application - the beginning of the first comparative period presented in the
first financial statements in which the lessee applies the new guidance
•
Recognize and measure all outstanding contracts within scope of guidance
•
Simplified retrospective approach
•
No specific effective date in exposure draft
February 10, 2011
Sale and Leaseback Transactions
Scope
If an asset is transferred and leased back, transaction to be accounted for under the
proposed ASU if the contracts are:
•
Entered into at or near the same time
•
Negotiated as a package with a single commercial objective
•
Performed either concurrently or consecutively
 Sale Criteria - at end of contract, seller-lessee transfers control and all but a trivial
amount of risks/benefits
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February 10, 2011
Sale and Leaseback Transactions
Seller-Lessee
•
If sale criteria are met:

Record sale pursuant to other GAAP

Record lease asset and obligation pursuant to lease standard
Buyer-Lessor
•
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If purchase criteria are met:

Account for purchase pursuant to other GAAP

Account for lease using the performance obligation approach
February 10, 2011
Questions?
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February 10, 2011
Thank you!