How to manage your fleet in crisis mode

IASB Content & Update

Pieter Waegenaer – Athlon car lease

Denis Férault - Arval

Reminder: Today’s accounting systems & standards of reporting

National “National” GAAP (US GAAP, French GAAP, Dutch GAAP) “General Accepted Accounting Principals ”: Interpretations and guidance determined by National Accounting Standards Board, including local rules for taxes.

International International Financial Reporting Standards (IFRS) : International rules on how to determine external annual reports.

IFRS & US GAAP get more and more similar, and the European Commission (via EFRAG) also want companies listed on Stock Exchange in Europe to adopt IFRS (Convergence project)

The Case for Change

• Consistency: Analysts want to find in the Balance sheet all the assets involved in the business, whatever their funding modality may be, to avoid analysis and adjustments made on limited / inconsistent assumptions

• Significance : leasing funds 1/3 of investments

• Transparency: Operating leasing is accused of hiding assets

– SEC : $1.25 trillion (undiscounted) non cancellable operating leases not on balance sheet in the US (however approx. 80% of amount is real estate leasing)

– The airline anomaly (however 70% of aircraft finance is now in finance lease)

– Many deals are effectively motivated by window dressing

• The “Risk and Reward” criterion is criticised

IASB/FASB: “Finance/Operating leases are similar products and should be

accounted for accordingly”

Lease reform, the rationales

IAS17 reform inital target • To dispose of a single accounting

treatment for ALL types of leases

– whether Financial Lease or Operating Lease (=> no “brightline”)

– for Lessees as well as Lessors

– recognized by both IASB (International Accounting Standards Board ) and FASB (US Financial Accounting Standards Board)

• With balance sheet recognition for OL Lessees : portion of the leased asset + corresponding liability

Resulting initial issues

• Drawing a new line between

– lease and purchase transactions

– lease vs service contracts

• Ensuring a consistency between Lessee and Lessor accounting

Lease accounting: how it works today

Balance sheet Initial YR 1 YR 2 YR 3

Equipment 0 0 0 0

Debt 0 0 0 0

P&L

Rent expense -1 326 -1 326 -1 326

Depreciation - 0 0 0

Interest expense - 0 0 0

Net before tax - -1 326 -1 326 -1 326

TODAY

An example:

• Asset cost: 4 000€ • Lessor’s residual: 15% • Lessee’s incremental borrowing

rate: 8% • Term: 36 months • Monthly rental: 110.54€

Linear impact on result

No balance sheet entry

IFRS for Leasing

A lease contract is one in which the right to control the use of

an underlying asset is transferred , for a period of time, from

the lessor to the lessee, in exchange for consideration.

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Lessor Lessee RoU

IFRS for Leasing

Introducing a balance sheet entry: The Right of Use model

The Right of use model Operating and finance lease to be treated in the same way, on balance sheet

Right to use the leased item Obligation to make payments

ASSET LIABILITY

On the asset side, a new concept called Right of use, measured as the discounted* sum of leasing rentals is booked and depreciated on a straight line basis

On his liability side, the same initial amount would be booked to reflect the contracted debt, but it is depreciated in a financial way, like a bank loan

(*) Discount rate: rate charged by the Lessor or lessee’s incremental borrowing rate if not available

At every closing, the Lessee has to reassess these initial amounts according to • the updated lease term (e.g. in case of recontracting)

• the likeliness of exercising renewal options.

IFRS for Leasing

Leasing Assets or Subscribing Services?

• Prelimanery guidance to define a Lease: “A Lease relates to a specific asset (not necessarily a unique asset), where the lessee controls usage of the asset and where the asset is not insignificant in fulfilling the service”

• Devil is in the detail to determine if it is a lease or a service (executory contracts) for:

– Mobility Services (Cars + Train Card)

– Managed (Print) Services

– Cloud Computing

• Service(s) are not recorded on the Balance Sheet

• Future: Finance Leases (FL) and Other-Than-Finance Leases (OTFL) may NOT be the same as today’s FL and OL

What’s on, What’s Off?

• FL and OTFL with a term > 12 Months will be on Balance,

• Contracts with a Term < 12 months are excluded and are Off Balance sheet

• Full Service or “Bundled” Contracts: Only the financing part of the lease is of importance and has to be taken into account

Current project – impact for the OL Lessee

• Balance sheet

Current IAS17 Project

Current IAS17 Project

► P&L

OL lessee B/S impacts

► Asset : « right of use » (RoU)

► Liability : rental payment obligation

Remaining issues

► Asset classification of the RoU

► Resulting amortization schedule

OL lessee expense

► Interest on liabilities

► Linear amortization of RoU

Consequence

► Decreasing P&L expense over

time (vs constant today) – also

called “front loaded” expense

Customer impacts No impacts for customers not listed on stock market, not reporting under IASB

Next Steps

Continuing Negotiation

Where does the lease reform stand today ? ► “Front loaded” expense for OL Lessee due to linear amortization

of the RoU

• the longer the lease, the bigger the issue

• systematic at implementation

2010 ED : inacceptable !

► “Interest based amortization” (IBA) to re-create a constant OL

Lessee expense profile

• “workable” and “useful”

• but not consistent with property depreciation rules (cf. IAS 16)

Feb 2012 : new proposal

► For FL 2010 ED ?

► For OL IBA ?

• New brightline ?

Compromise? ► For IASB 2010 ED ?

► For FASB IBA ?

• No norm convergence !

FL accounting rules must be similar to that of outright

purchases (ie. straight-line asset amortization)

Inapplicable for FL

CL/ outreach

Staff report

IASB position

FASB concern

► No P&L symmetry with Lessees ?

► Or, if for symmetry, straight-line retained for all leases or OL

• revert to straight-line revenue for OL Lessors

• “scope-out” OL Lessors from R&R model (back to current IAS 17)

How about lessors ?

Measurement over lease term

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How to allocate the cost of a lease over the lease term?

Approach A

Typically straight-line ROU amortisation

Decreasing interest on liability

Decreasing total expense

Typically increasing ROU amortisation, reflecting time

value of money

Decreasing interest on liability

Typically straight-line total expense

Approach B

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Approach C

ROU amortisation profile depends on how much of leased asset consumed by

lessee

Decreasing interest on liability

Varying total expense

Total payments allocated evenly over the lease term.

Effectively no financing.

Always straight-line total expense

Approach D

Measurement over lease term How to allocate the cost of a lease over the lease term?

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Approach A Approach B

Method for amortising ROU asset

Same way as other assets Different from other assets

Effect on net income Decreasing total expense, especially for long-term leases

Straight-line total expense for many leases

What does the effect on net income represent?

Same as purchasing an asset and separately financing it

Different from purchasing an asset and separately financing it

Presentation of amortisation and interest

Presented separately Combined as “lease expense”

Comparison of approaches

Comparison of approaches continued

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Approach C Approach D

Method for amortising ROU asset

Different from other assets Different from other assets

Impact to net income Total expense pattern depends on the lease • The higher the consumption, the

steeper the decline in expense • The lower the consumption, the more

straight-line the expense

Straight-line total expense for all leases

What does the effect on net income represent?

Same as purchasing the underlying asset and separately financing it

Different from purchasing an asset and separately financing it

Presentation of amortisation and interest

Presented separately Total payments allocated to lease expense evenly over the lease term

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0 1 2 3 4 5

1 2 3 4 5

Income statement

Approach A

0 1 2 3 4 5

ROU asset

Lease liability

1 2 3 4 5

Interest

Approach B

Balance sheet Balance sheet

Income statement

Comparison of approaches continued

0 1 2 3 4 5

20

Income statement

0 1 2 3 4 5

ROU asset

Lease liability

1 2 3 4 5

Lease …

Approach D

1 2 3 4 5

Approach C (equipment)

Balance sheet

0 1 2 3 4 5

Approach C (property)

1 2 3 4 5

Interest

Balance sheet Balance sheet

Income statement Income statement

Comparison of approaches continued

At best ... a slipping calendar

Last year

After the decision

to re-expose

Last expectations