accounting for leases now & next sessions/2011 seas material… · 1 becker gearty continuing...

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BECKER GEARTYCONTINUING PROFESSIONAL EDUCATION

Accounting for LeasesAccounting for LeasesNow & NextNow & Next

973.822.2220


Accounting for Leases (ASC 840 f/k/aSFAS 13)

•• Learning Objectives: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:Program Prerequisites: None•• Program/Course Level:Program/Course Level: Overview•• Program Content: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.

© 2011 DeVry/Becker Educational Development Corp. All rights reserved.

p•• Advanced Preparation:Advanced Preparation: None•• Type of Delivery Method:Type of Delivery Method: Live & Group Internet Based•• CPE Credits:CPE Credits: 2

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© 2011 DeVry/Becker Educational Development Corp. All rights reserved. 3


Accounting for LeasesDevelopments in Lease Accounting

FASB Proposed ASU


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Accounting for LeasesAccounting for LeasesDevelopments in Lease Accounting

FASB Proposed ASU



Accounting for Leases

I. OverviewA lease is a contractual agreement between a lessor, who conveys the right to use real or personal property (anconveys 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

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II. Operating LeasesA. 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.




B. Accounting for Operating Leases1. Lessee Accounting

a. Lease Rent ExpenseThe 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

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Accounting for Leasesb. 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 ImprovementsA l h ld i t i th t i tl ffi d t th t dA leasehold improvement is one that 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 ImprovementsThe 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 TermLeasehold improvements should be depreciated (amortized) over the lesser of:

a) Lease life


a) Lease life

b) Asset/improvement life

d. Rent KickerA premium rent payment required for specific events.

1) Period expensee. Refundable Security Deposit

Is reported as an asset until refunded by the lessor.

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Accounting for Leasesf. 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).

XAM

PLE

Rental-Agreement 5 years (60 months) @ $1,000 *First 6 months are free Net cost for five years Total months rented Monthly rental expense

$60,000 <6,000>

$54,000 ÷ 60 mo.

$ 900

First 6 months ( Mo. 1 – 6)


EX 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

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C. Leasing Issues1. Background and evolution

a Restatementsa. Restatementsb. SEC Staff Letter

2. Primary issuesa. Amortization of leasehold improvementsb. Rent holidaysc. Lease incentives


d. Disclosures

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Amortized by lessee over the shorter of:Their economic lives

Issue 1: Amortization of Leasehold Improvements

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, oronly if the lessee incurs a penalty in such amount that continuation of the lease appears, at inception, reasonably assured... is considered non-cancelable


KEY POINTLeasehold 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 exercise3. Add the renewal period to the initial term to determine appropriate term for

accounting purposes

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• Apply ASC 840-20-25; f/k/a/ FASB Technical Bulletin 85-3,

Issue 2: Rent Holidays

Apply ASC 840 20 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


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.

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• Landlord incentives for Leasehold Improvements:

Issue 3: Lease Incentives

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"

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Issue 4: Disclosures

Disclosures:

Footnotes, MD&A Critical Accounting Policies

Material LeaseAgreements

Amortization PeriodFor LHIs

Accounting Policiesfor Leases


Basis forContingent Rents

Provisions of MaterialLeases

original term, renewal periods, reasonably assured rent escalations, rent holidays, contingent rent, rent concessions, LHI incentives and other unusual provisions

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2. Lessor Accountinga. Fixed Asset

The cost of the property is included in theThe cost of the property is included in the lessor's property, plant and equipment.

1) Depreciation—over the asset's useful life

b. Rental IncomeRental income is reported on either the straight-line or other systematic method


straight-line or other systematic method.

DR Cash/rent receivable $XXX CR Rental income $XXX

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c. Security DepositsSecurity deposits required by the lease may be either refundable or nonrefundable:refundable or nonrefundable: 1) Nonrefundable—deferred by the lessor

(unearned revenue) and capitalized by the lessee (prepaid rent expense) until the lessorconsiders the deposit earned.

2) Refundable—treat as a receivable by the lessee and a liability by the lessor until the deposit is

f d d t th l


refunded to the lessee.

DR Cash $XXX CR Refundable deposit $XXX

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KEY POINT• Do not recognize security deposits as revenue in advance of their being earned

(violation of the Rule of Conservatism).

d. Temporary Difference

1) GAAP Rule – report prepaid rental income when earned

2) Tax Rule – report prepaid rental income when

(violation of the Rule of Conservatism).• Remember, revenue is only recognized when the earning process is complete; we

never anticipate revenue.


2) Tax Rule report prepaid rental income when received

e. Lease BonusThe lease bonus is deferred (unearned income) and amortized (into income) over the life of the lease.

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Accounting for Leasesf. 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).

MPL

E

Rental-Agreement

5 years (60 months) @ $1,000 *First 6 months are free Net rental income for five years Total months rented Monthly rental income

$60,000 <6,000>

$54,000 ÷ 60 mo.

$ 900

First 6 months ( Mo 1 6)


EXA

M 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

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III. Capital LeaseA capital lease transfers substantially all of the benefits and risks inherent in ownership of property to the lessee.p p p yi. 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.

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A. Lessee Capital Lease Criteria1. Must meet just one condition to capitalize.

DR Fi d t l d t $XXX 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 (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.

y ( ) p g

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EXAMPLE


Equipment FV is $3,500, lease payments are $1,000 per year, on 12-31 lease term is four years,

t lif i t asset life is ten years.

Incremental borrowing rate is 10%

No ownership

No written bargain

FV $3,500

P.V. Cost 1 2 3 4 $ 910 830 750

$1,000

$1,000

$1,000

$1,000


x 90% $3,150

750 680 $3,170

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B. Lessor: Sales-Type/Direct Financing Type Criteria1. If a lease, at inception, meets all three of the

following conditions it shall be classified by thefollowing conditions, it shall be classified by the lessor as a sales-type or direct financing lease, whichever is appropriate.

LLessee "owns" the leased property (meets any one of the four lessee's criteria)essee "owns" the leased property (meets any one of the four lessee's criteria)


UUncertainties do not exist regarding any unreimburseable costs to be incurred by ncertainties do not exist regarding any unreimburseable costs to be incurred by the lessor.the lessor.

CCollectibility of the lease payments is reasonably predictable.ollectibility of the lease payments is reasonably predictable.

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IV. Lessee (Capital Lease) AccountingA. 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

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1. Recording the Lease

a. Capitalized AmountTh l d th l t d li bilitThe 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.




a) Includes (all payments that the lessee is obligated to make):1) Required Payments2) Bargain Purchase Option

When the lease contains a bargain purchase option the leaseWhen 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 ValueThe 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

I i t d t b id b th l


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)

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KEY POINT

•Beginning = PV of an annuity due Periodic payment •Ending = PV of an annuity (in arrears/ordinary) Bargain OR •PV of $1 Guaranteed residual




b. Interest RateThe lessee uses the incremental borrowing rate, d t i d th l (l ) fdetermined as the lower (lesser) of:

1) Rate implicit in the lease (if known)

2) Rate available in market to lessee (not prime)


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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)


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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)


Depreciation Expense (per period)

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2. Period of Benefit (Depreciable Life)

a. Ownership Transfer and Written Bargain

1) Estimated economic life of the asset if the lessee1) 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.

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3. Summary

Depreciation Rules: (Capitalized "lease" asset salvage value): Depreciation Rules: (Capitalized lease asset—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)


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E. Summary of Lessee Capitalization Rules1. Capitalize

As PP&E on the balance sheet, the leased asset at the lower LESSER of:a. Costa. 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. LifeOwnership = PV of payments and required buyout Asset lifeWritten = PV of payments and bargain buyout Asset lifeNinety % FV = PV of payments (ignore option) Lease lifeSeventy-five % life = PV of payments (ignore option) Lease life

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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


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V. Lessor Accounting




A. Recording a Sales-Type LeaseFollowing are the terms which are important to gknow for sales-type leases:


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1. Gross Investment (lease receivable)The minimum lease payments plus any unguaranteed residual value accruing to the benefit of the lessor. This is grecorded as Lease Payments Receivable on the lessor'sbooks.

Lease payment + Unguaranteed residual value

Gross investment


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2. Net InvestmentThis is computed as the sum of the present value of the minimum lease payments and the present value of any p y p yunguaranteed residual value accruing to the benefit of the lessor, using the interest rate implicit in the lease.

Lease payments + Unguaranteed residual value

Gross investment


Gross investment x PV

Net investment

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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 >


Net investment Unearned interest revenue

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4. Cost of Goods SoldThe cost of the leased asset plus any initial direct costs, such as legal fees or commissions to the lessor, minus the g ,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

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5. Sales RevenueThe present value of the minimum lease payments is recorded as sales revenue. This does include the present pvalue of any guaranteed residual value but does not include the present value of any unguaranteed residual value.



EXAMPLE


Recording a SaleRecording a Sale--Type Lease with Unguaranteed Residual Value (Type Lease with Unguaranteed Residual Value (LessorLessor))

Assume that a lease with a tenAssume that a lease with a ten--year term requires rental payments of $5,000 on January 1 of year term requires rental payments of $5,000 on January 1 of each year. The each year. The lessor'slessor's cost for the leased asset is $35,000. The estimated fair value at the 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 end of the lease (unguaranteed residual value) is $4,000, and the lessorlessor retains ownership at retains ownership at the end of the lease. The implicit interest rate is 10 percent (P.V. of annuity due is 6.759 and 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 salesPV of $1 is .386). Compute the information necessary to record this sales--type lease.type lease.


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EXAMPLE (continued)


1. Gross investment = Minimum lease payments + Unguaranteed residual value = ($5,000 x 10 yrs) + $4,000 = $54,000




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)


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EXAMPLE (continued)


3. Unearned interest revenue = Gross investment – Net investment = $54,000 – $35,339 = $18,661



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


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EXAMPLE (continued)


5. Present value of lease payments (sale) = $5,000 x 6.759 = $33,795



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 i ti


inception.

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B. Recording a Direct FinancingSince no manufacturer's or dealer's profit is realized in a direct financing lease, the fair value of the leased property g , p p yequals the cost or carrying value at the inception of the lease. The information necessary to record this type of lease is:




1. Gross Investment (Lease Receivable)Gross investment equals the minimum lease payments plus the unguaranteed residual value and is recorded p gas Lease Payments Receivable.

Lease payments + Unguaranteed residual value

Gross investment


Gross investment

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2. Net InvestmentNet 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.

+Lease receivable

Unguaranteed residualGross investment


xGross investment

PVNet investment

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3. Unearned Interest RevenueThis is the gross investment less the cost of the leased property plus any initial direct costs. It is amortized over p p y p ythe 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

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VI. Sale-Leaseback




A. IntroductionIn 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?

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B. Terminology1. Selling Price

S lli i i th ti t d i i th lSelling price is the negotiated price in the sale-leaseback 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 SaleProfit or loss on the sale is the amount which would have been recognized by the seller-lessee assuming


have been recognized by the seller-lessee assuming there was no leaseback. It is calculated by subtracting book value from fair value (sale price).

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3. Excess Profit on Sale-Leasebacka. Operating Lease Excess Profit

The amount of profit on the sale whichThe amount of profit on the sale which exceeds the present value of the minimum lease payments.

Sale price < Asset NBV> T t ti i


Tentative gain < PV min. lease payments>

Excess gain

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b. Capital Lease Excess ProfitThe 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.

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4. Rights to Remaining Use of Property Retained by Seller-LesseeThe 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 p y p y gmay 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


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.

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Sale-Leaseback: Summary

Major Middle Minor

Major 90% or More

Middle 90%—10%

Minor 10% or Less

(Life or Sales Price)

Gain Defer All

(Amortize over leaseback)

Defer (up to PV of leaseback)

(Amortize over leaseback) No Deferral

Loss (NBV > FMV) (real economic losses)

Recognize Immediately




Other Losses (artificial loss)

Defer All

(Amortize over leaseback) Defer All

(Amortize over leaseback) Recognize

Immediately

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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.

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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) Therefore the amount of profit recognized is the amount in excess

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) Therefore the amount of profit recognized is the amount in excess of the fair market value ($450,000). 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 $500,000Less book value (100,000)Total profit 400,000Less 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

of the fair market value ($450,000). 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 $500,000Less book value (100,000)Total profit 400,000Less 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) $ 61,200Less one year recognition of deferred profit

($153,000 ÷ 3 years) (51,000)Rent expense 12/31/Yr 1 $ 10,200

Carlson’s rent expense for the year is calculated as follows:Annual rent payments ($5,100 x 12 months) $ 61,200Less one year recognition of deferred profit

($153,000 ÷ 3 years) (51,000)Rent expense 12/31/Yr 1 $ 10,200

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Accounting for LeasesDevelopments in Lease AccountingDevelopments in Lease Accounting

FASB Proposed ASU


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SEC Staff Report to Congress

I. July 2005 – SEC Staff Issued Report to CongressA. Required under §401 (c) of Sarbanes-Oxley ActB. The extent of Off-Balance Sheet ArrangementsC. Whether current financial statements

transparently reflect the economics of off-balance sheet arrangements

D. Among many topics, Lease Accounting is


discussed

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Improving Financial TransparencyObjectives-Oriented Standards

II. SEC recommends: Accounting standards that are principle-based or "objectives-oriented":

Clearly state the accounting objectiveClearly state the accounting objective Minimize the use of exceptions in a standardAvoid use of percentage tests ("bright lines") to evade intentBased on an approved and consistently applied conceptual frameworkProvide 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."

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SEC Standard SettingRecommendations—Leases

IV. Reconsider Accounting for LeasesA. Repeatedly identified as an area to be reexamined by the

FASBFASB.

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


reporting.

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• Reconsider Accounting for Leases (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

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V. The lease project is complex and controversial

VI Leases have many different terms including:VI. Leases have many different terms including:

contingent rentsoptional extensionspenalty clausespurchase options



Accounting for LeasesDevelopments in Lease Accounting

FASB Proposed ASUFASB Proposed ASU


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Proposed FASB ASU on Leases


General Provisions of Lease Accounting

Lessee AccountingLessor Accounting

Developments in Lease Accounting



Other Lease Accounting TopicsEffects on Financial ReportingTransition and Effective Date

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LeasesGeneral ProvisionsI. Corporate Behavior – Why Enter into a Lease?

A. Avoid large initial cash outlaysB. Features and options offered by lessorC. Financial flexibilityD. Off-balance sheet financingE. Tax Advantages of capital lease – deductions for:

1. Depreciation2. Interest Expense3. Synthetic Leases

F. Start-up company may lack credit to borrow from bank


p p y yG. Restaurants and Retailers:

1. No need for lease vs. buy decision (shopping malls)2. Embedded in business model3. Prime Location

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Leases – 2010 Exposure Draft

II. Leases – 2010 Exposure DraftA. On August 17, 2010, the ISAB and the FASB issued an exposure

draft on Leases that proposes that a new standard on lease p paccounting 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

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LeasesGeneral ProvisionIII. 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.

IV. ScopeIV. ScopeA. 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; and4. 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.

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LeasesGeneral ProvisionIV. Scope

B. Includes:1. Combined services and lease contracts (bifurcate lease)2 Short term leases2. Short term leases3. Sale-leasebacks4. Subleases5. 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.




• . KEY POINT

DEFINITION OF A LEASE AS UPDATED BY THE BOARDS ON APRIL 12 2011DEFINITION 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.

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• . KEY POINT

T i di B d d i i h th th ill b i l d d iTopics pending Board decision on whether they will be included 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.



LeasesGeneral ProvisionV. Types of Leases

A. At the Feb 17th 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: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.

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LeasesGeneral Provision

KEY POINTKEY POINTOwnership transfers at end of lease (upon final payment or required buyout)Written option for bargain purchaseNinety (90%) percent of leased property F.V. <= P.V. of lease paymentsSeventy-five (75%) percent of asset economic life is being committed in lease term

Operating Leases




• 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.T f f th titl f th t l i i ffi i t f tit t d id


• Transfer of the title of the asset alone is insufficient 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.

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Other Lease Accounting TopicsEffects on Financial Reporting




Effects on Financial ReportingTransition and Effective Date

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Lessee Accounting - General

General• A lessee’s rights and obligations L R iL R iA lessee 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

Lessee Recognizes on Lessee Recognizes on Balance SheetBalance Sheet

“Right“Right--ofof--use” Assetuse” Asset

Liability to Liability to make Lease make Lease PaymentsPayments


replaced with amortization of the right-of-use asset and interest expense on the lease obligation

PaymentsPayments

Income StatementIncome Statement

Amortization Amortization ExpenseExpense

Interest ExpenseInterest Expense

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Lessee Accounting – Initial Measurement

I. Initial MeasurementA. Initially recognize asset and liability at present value of lease

payments to be made.yB. 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.


incremental borrowing rate.D. It also includes:

1. Options (renewal and termination) in lease term2. Contingent rentals, residual value guarantees and termination

payments

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Lessee Accounting – Initial Measurement

E. Measurement Date1. 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:


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.

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Lessee Accounting – Lease Term

II. Lease TermA. 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 tothe 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


y p ysignificant 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.”

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Lessee Accounting – Lease Payments

III. Lease PaymentsA. Concept of “minimum lease payments” is gone.B “L t ” ill i l d t t l t l ti t dB. “Lease payments” will include contractual payments plus estimated

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


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.

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IV. Lease Payments3. Termination penalties – should be consistent with the

accounting for options to extend or terminate a leaseaccounting for options to extend or terminate a lease.4. Guaranteed residual values – except for amount guaranteed

by unrelated third parties.




C. Contingent Rentals and Residual Value Guarantees1. The exposure draft provides that contingent rentals and

residual value guarantees must be estimated and accounted es dua a ue gua a tees ust be est ated a d accou tedfor 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


calculation.

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b. When determining the present value of lease payments, the lessee must include contingent rents, residual value guarantees, and expected payments under termination penalties.

2. Initial Measurement: The underlying asset would be initially

KEY POINTThis 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.


measured at the amount of the liability and adjusted for any prepaid lease rentals and any recoverable initial direct costs that the lessee incurs.

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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 POINTUnder 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.


minimum calculation regardless of their probability of occurrence.

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Lessee Accounting – Subsequent MeasurementV. Subsequent Measurement

A. Reassess the carrying amount of the lease payment obligation if there is a significant change

B. Accounting for Subsequent Measurement1. Changes in lease terms: Adjust the right-of-use asset and the

obligation to make rental payments2. 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-of-use asset and the obligation to make rental payments


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KEY POINTNo changes required for the incremental borrowing rate. The discount rate is locked in at initial measurement


Lessee Accounting – Financial Reporting

VI. PresentationA. Balance Sheet

1. Right of use assets presented with PP&E but separate from non-1. Right of use assets presented with PP&E but separate from nonlease 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 Statement1. 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.

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D. Updated Requirements – Tentative Decisions as of July 21, 20111. Statement of Financial Position - Lessees may separately

present or disclose the values related to right of use assets p ese t o d sc ose t e a ues e ated to g t o use assetsand 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.




2. Statement of Cash Flows:a. Cash paid for leases payments is classified in financing

activities. act t esb. 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.

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VII. DisclosureA. As of the July 21st meeting the boards tentatively decided on the

following disclosure requirements: g q1. 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


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.

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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.

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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


underlying asset, or initial direct costs incurred on a lease.4. Information about arrangements that are no longer determined to

contain a lease.

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C. Future Commitments – The 2 Boards Differ on This Point. 1 FASB: lessee should disclose the future contractual1. 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.


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General Provisions of Lease Accounting for LeasesAccounting







Lessor Accounting – General

I. Dual ModelA. Performance Obligation Approach

1. Lease receivable and liability to permit lessee’s use of assety p2. Interest income and lease income as obligation is satisfied

B. De-recognition Approach1. Used only if lessor does not retain significant risks and rewards

of ownership of leased asset2. 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 purchaseNinety (90%) percent of leased property F.V. <= P.V. of lease paymentsSeventy-five (75%) percent of asset economic life is being committed in lease term

Operating Leases

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II. Estimates for BothA. Lease term, contingent payments, other assumptions similar to

lessee accounting. essee accou t gB. Predict lessee’s behavior as to whether or not lessee is likely to

exercise the options built into the lease





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III. Performance Obligation ApproachKEY POINT


A. When risks and benefits of underlying asset are retained, lessorconsiders:

p ( p p y q y )Written option for bargain purchaseNinety (90%) percent of leased property F.V. <= P.V. of lease paymentsSeventy-five (75%) percent of asset economic life is being committed in lease term

Operating Leases


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, or3. Material non-distinct services provided in the lease contract.

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B. The underlying leased asset remains on the lessor’s balance sheet.

C. The lessor recognizes:C e esso ecog es1. 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.


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E. Subsequent measurement: Performance obligation approachSubsequent measurement of the lessor’s receivable would be at amortized cost using the effective interest method, resulting in interest incomeincome.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.

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F. Reassessment: Performance Obligation Approach1. The exposure draft requires the lessor to reassess the amount of

expected lease payments, the lease term, contingent rentals, p p y , , g ,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 Changesa) Changes to lease term: Adjust the lease liability and the right

to receive lease payments.b) For contingent cash flows:


b) For contingent cash flows:1) Recognize in revenue, if the performance obligation has

been already satisfied2) Recognize as an adjustment to performance obligation if

obligation has not yet been satisfied

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Performance Obligation – Lessor Financial Statement Presentation

G. Presentation: Performance Obligation Approach

Balance SheetUnderlying Asset xxRight to Receive Lease Payments xxLease Liability (xx)Net Lease Asset / (Liability) xxIncome Statement


Lease Income xxDepreciation Expense (xx)Interest Income xxSource: August 2010, IASB Exposure Draft Snap Shot: Leases

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IV. Derecognition Approach:V. KEY POINT


A. Assumes that the lessor has performed by delivering the leased asset

p ( p p y q y )Written option for bargain purchaseNinety (90%) percent of leased property F.V. <= P.V. of lease paymentsSeventy-five (75%) percent of asset economic life is being committed in lease term

Operating Leases


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) and2. Records revenue

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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

KEY POINT

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 leaseE. 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


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.

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G. Subsequent Measurement: Derecognition Approach1. The exposure draft proposes that, from the onset of the lease, the

lessor would measure the leased asset at amortized cost using the geffective 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


p ;b) Recognize other changes in the carrying amount of the

leased asset in profit or loss.

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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

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Lessor Accounting – Changes in Estimate and Remeasurement

H. Reassessment: Derecognition Approach:1. Reassessment resulting in a change in term - change in the

lease receivable is allocated to the rights derecognized and the ease ece ab e s a ocated to t e g ts de ecog ed a d t eresidual asset.

2. For contingent cash flows, changes in the lease receivable are adjusted through revenues.


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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’sbusiness 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


gb. 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

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V. Current StatusA. Lessor accounting is still in flux. The information presented

here reflects the original exposure draft. There is much e e e ects t e o g a e posu e d a t e e s ucongoing 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.


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Current StatusB. May 17, 2011 meeting

1 Discussed whether there should be one or two1. 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.

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• . KEY POINT

If i l h i d th b d t t ti l d id d th tIf a single approach is used, the boards tentatively decided that:

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 lessorcharges the lessee (FASB: 5 to 2; IASB: unanimous)


charges the lessee. (FASB: 5 to 2; IASB: unanimous).

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V. Current StatusC. 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.


g p3. 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.

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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 a1. 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


y g y g ymeasure the residual asset by accreting it over the lease term using the rate the lessor charges the lessee.

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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.

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7. Leases of investment property measured at fair value and short-term leases are excluded from the receivable-residual approach. pp

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.


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EXAMPLE

Derecognition – Lessor Financial Statement Presentation B l Sh tBalance SheetResidual Asset xxRight to Receive Lease Payments xxIncome StatementRevenue xxCost of Goods Sold (xx)(gross or net based on business model) $


Interest Income xxSource: August 2010, IASB Exposure Draft Snap Shot: Leases

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General Provisions of Lease AccountingAccounting for Leases


Other Lease Accounting Topics

Effects on Financial ReportingTransition and Effective Date




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Other Lease Accounting Issues

I. Short-term LeasesA. Lease terms 12 months or less (including renewals).B. Lessee and Lessor may elect to use the lease guidance, orB. Lessee and Lessor may elect to use the lease guidance, orC. Lessee may recognize lease payments in profit or loss on a straight-

line 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.




II. Sale-LeasebacksA. 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


entire underlying asset and leases back a right of use asset relating to part of the underlying asset.

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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 transactiona 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


a ue, t e assets, ab t es, ga s a d ossesrecognized should be adjusted to reflect current market rentals.

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III. SubleasesA. Account for head lease and sub-lease as separate transactions.B. An intermediate lessor, as a lessee in a head lease arrangement,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.

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Cash $ XAccounts 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 $ XLi bilit t k l t X


Liability to make lease payments X

Total Liabilities $ X


General Provisions of Lease AccountingAccounting


Other Lease Accounting TopicsEffects on Financial Reporting

Transition and Effective Date

Accounting for LeasesDevelopments in Lease

AccountingFASB Proposed ASUFASB Proposed ASU


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Lease AccountingFinancial ReportingI. Balance Sheet

A. Current pro-forma capitalizations of operating leases are likely to understate to amounts presented under the new lease model.u de state to a ou ts p ese ted u de t e e ease ode

Reported Assets are Reported Assets are HigherHigher

Asset Turnover RatioAsset Turnover Ratio

DebtDebt--toto--Equity RatioEquity Ratio

Return on EquityReturn on Equity


Current & NonCurrent & Non--current current Liabilities are HigherLiabilities are Higher

DebtDebt toto Equity RatioEquity Ratio

Working CapitalWorking Capital

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Lease AccountingFinancial ReportingII. Income Statement

ffffEBITEBIT

Lower rent expense partially offset by Lower rent expense partially offset by increased amortizationincreased amortization

Higher amortization expense and Higher amortization expense and interest expenseinterest expense

EarningsEarnings

EPSEPS

OMOM

Statement of Cash FlowsStatement of Cash Flows


Cash flows associated with leases are Cash flows associated with leases are classified as financing activitiesclassified as financing activities

Operating Cash FlowOperating Cash Flow

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Disclosures

III. Disclose:A. Quantitative and qualitative information identifying and explaining

amounts recognized in the financial statements arising from leases.a ou ts ecog ed t e a c a state e ts a s g o easesB. 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; andD. Information about the principal terms of any lease that has not yet

commenced if the lease creates significant rights and obligations for the company.



Disclosures

IV. Disclose:A. A reconciliation between the opening and closing balances of right-

of-use assets and obligations to pay rentals, disaggregated by o use assets a d ob gat o s to pay e ta s, d sagg egated byclass 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

f f


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

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Disclosures

V. Disclose:A. Under the performance obligation approach:

1 Lessors would classify collection of the lease receivable and1. 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, or3. There is a sale-leaseback transaction



Disclosures

Lessee - Reconciliation Roll-forward DisclosureRight-of-use

AssetsLiability to make Lease Payments

Balance at January 1, 20X0 1,000$ (1,000)$ Changes in estimates from:

Contractual Obligations Total Obligations

20X0 XX XX20X1 XX XX20X2 XX XX20X3 XX XX 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) -

20X3 XX XX20X4 XX XX20X5 and Thereafter XX XX

Total $ XXX $ XXX


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)$

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Accounting for LeasesDevelopments in Lease

AccountingFASB Proposed ASUFASB Proposed ASU



Lease AccountingTransition and Effective DateI. Effective Date

A. Not yet determined.B Most likely 2013B. Most likely 2013.C. Some believe it may be later.


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Lease AccountingTransition and Effective DateII. Transition

A. No grand-fathering B. Required to inventory all lease contracts and for each:

1. Determine the lease term and2. 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


periodG. 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 termI. Deferred Tax and Sales/ Use Tax Considerations

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Lease AccountingOther Considerations

1. Valuations of Leases in M&A2. Accounting for tenant incentives3 IT systems for tracking3. IT systems for tracking4. Controls over assumptions5. When to re-measure assumptions


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Lease AccountingGeneral UpdateA. 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 accountingO e o t o app oac es o esso accou t g2. Disclosure on short term leases



Final Polling Question:Which is your preference?A. Questions.B. Comments.C. Just give me my CPE Certificate!

Thank you!


Thank you!

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