overview - fasb exposure draft leases (topic 840) february 2, 2011 douglas boedeker, cpa, cma...

Overview - FASB Exposure DraftLeases (Topic 840)

February 2, 2011

Douglas Boedeker, CPA, [email protected]

mailto:[email protected]

© Copyright Tate & Tryon 20102

Course Outline

Why is the exposure draft being issued?

FASB timeline

Project scope

Recording by lessees

Work through an example

Recording by lessors

Transition


The FASB/IASB Lease Project – WHY?

Leases are an important source of finance – more information required.

Concern over lack of comparability.

Concern over “bright-line” test for operating vs. capital lease.

3


FASB Timeline

Exposure Draft Issued – August 17, 2010

Public Comment Period Ended – December 15, 2010

- 778 comment letters were received!

Final standard currently anticipated for release sometime in 2Q2011

4


Scope of the proposed standard

Simple – ALL Leases

Except :

Leases of intangible assets

Leases of mineral rights, etc.

Leases of biological assets

Distinct service components of a lease agreement should be accounted for in accordance with the new ED on revenue from contracts with customers.

5


What is a “lease”?

“A contract in which the right to use a specified asset is conveyed, for a period of time, in exchange for consideration.”

6


Initial Recording by a Lessee

1. Determine the “lease liability”(Future anticipated cash payments discounted to present value at either the lessee’s incremental borrowing rate or the rate implicit in the contract.)

2. Determine the “right of use asset”(Lease liability plus initial direct costs of acquiring the lease.)

7


Subsequent Recording by a Lessee

Amortize the “right of use asset”. (Probably on a straight-line basis.)

Adjust the lease liability using the effective interest rate method.

(Essentially treated like a note payable.)

Reassess significant assumptions and adjust for current facts and circumstances. (Discount rate does NOT change.)

Thus, the P&L reflects amortization expense and interest expense.

8


Items requiring judgment

The lease term to be used when recording the lease is the longest possible term that is more likely than not to occur.

Contingent rentals must be estimated up-front using a probability analysis.

Payments to be made under residual value guarantees should also be estimated and factored in to the initial lease liability.

At the end of each reporting period the following items must be reassessed and adjusted as necessary:

- Lease term- Contingent rentals and residual value guarantees- Right of use asset (for impairment)

9


Term of Lease Probability Cumulative Probability

5 Years 45% 100%

10 Years 30% 55%

15 Years 25% 25%

Assum

e a tenan

t enters into a five year lease w

ith tw

o five-year rene

wal option

s.

The ten

ant must

assess the likeliho

od of w

hether each rene

wal option

w

ill be exercise

d.

HIN

T: Alw

ays

start this analysis

with

the longest

possible term a

t the botto

m and

work your w

ay up!

10

Determining the “lease term”

A 10 year term will be used when initially recording the lease.


Contingent Rents

Le

t’s a

ssum

e

tha

t ou

r le

ase

in

clud

es a

p

rovisio

n

for a

nn

ua

l “p

ass-

thro

ug

hs”

ba

sed

on

in

crea

ses

in b

uild

ing

o

pe

ratin

g

exp

en

ses

an

d

pro

pe

rty ta

xes.

Th

ese

are

a

nticip

ate

d to

start

at

$5

0,0

00

p

er ye

ar.

Ou

r te

na

nt’s

incre

me

nt

al

bo

rrow

ing

ra

te is

8%

.

11

Outcome #1 Outcome #2 Outcome #32% Annual Growth 5% Annual Growth 8% Annual Growth Total

547,486$ 628,895$ 724,328$

Present value at 8% 357,824$ 403,292$ 456,010$

Probability 50% 45% 5%

Expected Outcome 178,912$ 181,481$ 22,801$ 383,194$

Contingent Rent CalculationOperating expense pass-throughs

(Using 10 year lease term)

Gross expenses over lease term


Calculating the Liability and Asset

Let’s assume tha

t our lea

se m

andates annual fixed “base” paym

ents of $1,000

,000 p

er year.

Legal fees of

$10,00

0 were

incurred a

s part of the

revie

w of

the lease docum

ent.

Based on

the lease term

and

contingent rental

analysis

performed, th

e liability and asset are calculated as follow

s……

.

12

Gross fixed lease payments - 10 years 10,000,000$

Present value of fixed payments at 8% 6,868,429 Add, present value of contingent rents 383,194

"Lease Liability" 7,251,623

Add, direct costs (legal review) 10,000

"Right of Use" Asset 7,261,623$


Subsequent entries for year one

13

Debit Credit

Entry to account for lease paymentsCash 1,050,000$ Lease liability 493,148$ Interest expense 556,852$

Entry to account for amortization of right of use assetAmortization expense 726,162$ Accumulated amortization 726,162$

Net P&L Impact 1,283,014$

P&L impact under existing GAAP would have only been $1,050,000.


Lessor Accounting

Does the lessor retain significant risks or benefits of the underlying asset during or subsequent to the expected lease contract?

If NO, use the “Derecognition Approach”

If YES, use the “Performance Obligation Approach”

14


Lessor Accounting – Derecognition Approach

Leased asset is removed from the books (treated like a sale, term is “lease expense” instead of COGS).

Receivable is booked for the “right to receive lease payments”.

Recognizes the bulk of revenue up front, with interest income recorded on the subsequent cash payments.

15


Lessor Accounting – Performance Obligation Approach

Leased asset stays on books (and depreciated as usual).

Receivable is booked for the “right to receive lease payments”.

Liability (unearned revenue) is booked for the corresponding “lease liability”.

The unearned revenue is recognized over time (likely straight-line basis). Term to be used is “lease income”.

Interest income is recognized on the receivable.

16


Transition

“Simplified Retrospective Method”

Determine all remaining lease payments as of date of implementation, discount, and record the corresponding asset and liability.

Implementation Date

Nothing definite yet, perhaps 2013 or later for nonpublic entities?

17


Good Luck!

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overview - fasb exposure draft leases (topic 840) february 2, 2011 douglas boedeker, cpa, cma...

Documents

copyright tate tryon

year lease

lease agreement

capital lease

initial lease liability

fasbiasb lease project

year term

initial recording