overview - fasb exposure draft leases (topic 840)

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Overview - FASB Exposure Draft Leases (Topic 840) February 2, 2011 Douglas Boedeker, CPA, CMA [email protected] 202-419-5106

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Overview - FASB Exposure Draft Leases (Topic 840). February 2, 2011. Douglas Boedeker , CPA, CMA [email protected] 202-419-5106. Course Outline. Why is the exposure draft being issued? FASB timeline Project scope Recording by lessees Work through an example Recording by lessors - PowerPoint PPT Presentation

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Page 1: Overview - FASB Exposure Draft Leases (Topic 840)

Overview - FASB Exposure DraftLeases (Topic 840)

February 2, 2011Douglas Boedeker, CPA, [email protected]

Page 2: Overview - FASB Exposure Draft Leases (Topic 840)

© 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

Page 3: Overview - FASB Exposure Draft Leases (Topic 840)

© Copyright Tate & Tryon 2010

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.

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Page 4: Overview - FASB Exposure Draft Leases (Topic 840)

© Copyright Tate & Tryon 2010

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

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Page 5: Overview - FASB Exposure Draft Leases (Topic 840)

© Copyright Tate & Tryon 2010

Scope of the proposed standard

Simple – ALL Leases

Except :Leases of intangible assetsLeases 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.

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Page 6: Overview - FASB Exposure Draft Leases (Topic 840)

© Copyright Tate & Tryon 2010

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.”

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Page 7: Overview - FASB Exposure Draft Leases (Topic 840)

© Copyright Tate & Tryon 2010

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.)

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Page 8: Overview - FASB Exposure Draft Leases (Topic 840)

© Copyright Tate & Tryon 2010

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.

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Page 9: Overview - FASB Exposure Draft Leases (Topic 840)

© Copyright Tate & Tryon 2010

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)

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Page 10: Overview - FASB Exposure Draft Leases (Topic 840)

© Copyright Tate & Tryon 2010

Term of Lease Probability Cumulative Probability

5 Years 45% 100%

10 Years 30% 55%

15 Years 25% 25%

Assum

e a tenant enters into a five year lease w

ith tw

o five-year renew

al options.

The tenant must

assess the likelihood of w

hether each renew

al option w

ill be exercised.

HIN

T: Alw

ays start this analysis w

ith the longest possible term

at the bottom

and w

ork your way

up!

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Determining the “lease term”

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

Page 11: Overview - FASB Exposure Draft Leases (Topic 840)

© Copyright Tate & Tryon 2010

Contingent Rents

Let’s assum

e that our lease includes a provision for annual “pass-throughs” based on increases in building operating expenses and property taxes. These are anticipated to start at $50,000 per year.

Our

tenant’s increm

ental borrow

ing rate is 8%

.

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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

Page 12: Overview - FASB Exposure Draft Leases (Topic 840)

© Copyright Tate & Tryon 2010

Calculating the Liability and Asset

Let’s assume that

our lease m

andates annual fixed “base” paym

ents of $1,000,000 per year.

Legal fees of $10,000 w

ere incurred as part of the review

of the lease docum

ent.

Based on the

lease term and

contingent rental analysis perform

ed, the liability and asset are calculated as follow

s……

.

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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$

Page 13: Overview - FASB Exposure Draft Leases (Topic 840)

© Copyright Tate & Tryon 2010

Subsequent entries for year one

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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.

Page 14: Overview - FASB Exposure Draft Leases (Topic 840)

© Copyright Tate & Tryon 2010

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”

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Page 15: Overview - FASB Exposure Draft Leases (Topic 840)

© Copyright Tate & Tryon 2010

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.

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Page 16: Overview - FASB Exposure Draft Leases (Topic 840)

© Copyright Tate & Tryon 2010

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.

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Page 17: Overview - FASB Exposure Draft Leases (Topic 840)

© Copyright Tate & Tryon 2010

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?

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Page 18: Overview - FASB Exposure Draft Leases (Topic 840)

© Copyright Tate & Tryon 2010

Good Luck!

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