The Year Was 8/8/2014

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FASB- Lease Accounting

Re-Exposed

Jeff Dieleman CPA

The Year Was…

Moss Adams LLP | group name | page 1Moss Adams LLP | page 1

The Year Was…

 The Dow Jones closed at 1,004

 A gallon of gas was $.76

 The Apple Computer Company was formed

 The cost of a Superbowl ad was $110 000

 The cost of a Superbowl ad was $110,000

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Popular Musicians and songs

Barry Manilow Diana Ross Paul Simon

Paul McCartney and Wings

The Year Was…

Elton John Rod Stewart Queen ABBA

The Year Was…

• Gerald Ford was the President of the United States

The Year Was…

And perhaps most notably…

FAS 13-

Accounting for Leases was Issued

FAS 13-

Accounting for Leases was Issued

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The Year Was…

1976

• Project Rationale • Project Chronology • Current Authority FASB

Agenda

y

• FASB Proposed Model

 SEC research shows $ 1.25 trillion in non‐cancelable future cash flows being reported in footnotes of US public companies.

Project Rationale

 Leases being accounted for as Operating leases may amount to several trillion $$ worldwide.

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• Current guidance for leases probably does not align with definitions of assets and liabilities under conceptual frameworks for the FASB.

• Financial statement users (investors, lenders, rating agencies) are adjusting statements for operating leases

Project Rationale

agencies) are adjusting statements for operating leases. • Leases are being structured to meet a predetermined accounting result. • Lease accounting issues provide an opportunity for convergence. Conceptual Questions:

• Does the lessee’s right to use the leased item meet the definition of an asset?

Concepts statement No. 3: “Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.

Project Rationale

Moss Adams LLP | group name | page 10Moss Adams LLP | page 10 An asset has three essential characteristics:

(a) it embodies a probable future benefit that involves a capacity, singly or in combination with other assets, to contribute directly or indirectly to future net cash inflows,

(b) a particular enterprise can obtain the benefit and control other’s access to it, and

(c) the transaction or other event giving rise to the enterprise’s right to or control of the benefit has already occurred.

Conceptual Questions: • Does the lessee’s obligation to make payments under the lease represent a liability? “Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of pas transactions or events

Project Rationale

events. A liability has three essential characteristics: a) it embodies a present duty or responsibility to one or more other entities that entails settlement by probable future transfer or use of assets at a specified or determinable date, on occurrence of a specified event, or on demand, b) the duty or responsibility obligates a particular enterprise, leaving it little or no discretion to avoid the future sacrifice, and c) the transaction or other event obligating the enterprise has already happened.

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• June 2005 ‐ SEC report on off‐balance sheet

financial accounting implications provided impetus for the project.

• April 2006 Project added to joint FASB / IASB

Project Chronology

• April 2006 ‐ Project added to joint FASB / IASB agenda at joint meeting in London. • February 2007 ‐ First meeting of Joint Working Group on Lease Accounting in London. Current Accounting Developments Leases: Timeline

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FASB Statement No. 13 Accounting for Leases ‐ Issued November 1976.

• FAS 27 ‐ …Renewals or Extensions of existing or Direct Financing

Current Authority

(Pre‐Codification)

g g

Leases – an amendment to FAS 13

• FAS 28 – Accounting for Sales with Leasebacks – an amendment

to FAS 13

• FAS 29 – Determining Contingent Rentals – an amendment to

FAS 13

• FAS 98 – Accounting for Leases ‐ Sale‐Leasebacks

FASB Statement No. 13 – Issued in 1976

• Established standards of financial accounting for leases by lessees and lessors.

• For lessees, a lease is a financing transaction called a

Current Authority

capital lease if it meets any one of four specified criteria; if not, it is an operating lease. FASB Statement No. 13 ‐ Four Criteria for Financing Lease treatment • Transfer of ownership to lessee at end of lease term. • Lease contains a bargain purchase option.

Current Authority

g p p • Lease term equal to or greater than 75% of estimated economic life of leased property. • Present value of lease payments equals or exceeds 90% of fair value of leased property.

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Let’s Fastforward

Scope exceptions

• The proposed guidance would apply to all leases other

than the following:

– Leases of intangible assets

FASB Proposed Model

Leases of intangible assets

– Leases to explore for or use minerals, oil, natural gas, and similar non‐regenerative resources

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Definition of a lease

• defined a lease as a contract in which the right to usea specified asset (the underlying asset) is conveyed, for a period of time, in exchange for consideration.

FASB Proposed Model

Overview of Proposed Accounting Models Overview of Proposed Accounting Models –– LesseeLessee

Lessee Right‐of‐Use Model Recognize Recognize liability to make estimated Practical Expedient: ‐Equipment leases are accelerated (Type A) ‐Land/Building leases are straight line (Type B)

Balance Sheet “right‐of‐use” asset to make estimated future lease payments Interest & Amortization (I&A) Method (most equipment leases) TYPE A Single Lease Expense (SLE) Method (most real estate leases) TYPE B Balance Sheet Income Statement  Under the proposed model, a lessee would recognize a right‐of‐use asset representing its ability to use the leased asset for the lease term, and a corresponding liability for its obligation to pay rentals.

 The initial measurement of the lease liability would be at the

FASB Proposed Model

(Lessee)

 The initial measurement of the lease liability would be at the

present value of the lease payments, discounted using the lessee’s incremental borrowing rate or the interest rate implicit in the lease.

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 Type A ‐ Accelerated (AKA Interest & Amortization Method)in cases for

which the lessee acquires and consumes more than an insignificant portion of the underlying asset over the lease term.

Amortize the right of use asset on a systematic basis (generally straight line)

FASB Proposed Model

Expense Recognition‐Lessee

Moss Adams LLP | group name | page 24Moss Adams LLP | page 24 (generally straight line) Interest expense would be calculated on the effective interest method Combined amortization expense & interest expense results in front loaded pattern of total lease expense Recognize amortization expense & interest expense separately in the income statement

FASB Proposed Model

Type A Expense Recognition‐Lessee

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 Type B ‐ Straight‐line (AKA SLE)in cases where the lessee acquires and consumes an insignificant portion of the underlying asset over the lease term Interest expense calculated under the effective interest method

FASB Proposed Model

Expense Recognition‐lessee

Moss Adams LLP | group name | page 27Moss Adams LLP | page 27 method Measure the right of use asset each period as a balance figure such that total lease expense would be recognized on a straight line basis. Recognize lease expense as one amount in the income statement.

 The lease term is the non‐cancellable period for which the lessee has contracted with the 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

FASB Proposed Model

Lease Term  A lessee should reassess the lease term only when there is a significant 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.  Similar to existing GAAP

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• Includes fixed lease payments

• Variable lease payments that depend on an index or a rate

( h h d k )

FASB Proposed Model

(Measurement)

(such as the Consumer Price Index or a market interest rate)

• Excludes other variable lease payments unless those

payments are in‐substance fixed payments.

Contracts with service components

• If a contract contains a lease, but also contains a service component, the distinct service components would be

FASB Proposed Model

(Lessee)

component, the distinct service components would be accounted for in accordance with other GAAP).

Proposed Disclosures

• Must disclose Type A and Type B ROU assets separately on the balance sheet and disclose the line item where located • Must disclose Type A and Type B liabilities separately on

FASB Proposed Model

yp yp p y the balance sheet and disclose the line item where located

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Proposed Disclosures

• 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.

FASB Proposed Model

• Short Term Leases‐ required to disclose the amount of expense and any other qualitative disclosures.

Proposed Disclosures

Lessors • Information about the nature of its leases, as well as information about significant assumptions and judgments made in applying the leases requirements;

FASB Proposed Model

• A table of lease income during the reporting period; and • A maturity analysis of the undiscounted cash flows that comprise the lessor’s lease receivables for each of the first 5 years following the reporting date (and a total for thereafter)

Cash Flow Presentation

• Cash payments for the principal portion of the lease liability arising from Type A leases within financing activities • Cash payments for the Interest portion of the lease liability

FASB Proposed Model

arising from Type A leases within operating activities • Cash payments arising from Type B leases within operating activities.

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Key Impacts

• For the lessee‐other than some short term leases, all leases will be on the balance sheet

FASB Proposed Model

• Changes to both B/S and I/S • Could impact key ratios and covenant calculations • Accelerated expense recognition Two Models for the Balance Sheet and Income Statement 1. Receivable‐Residual Approach (Type A) • Used for most equipment leases • Record a lease receivable for the right to receive payments at the present l f th l t

FASB Proposed Model

Lessor Accounting

value of the lease payments • Derecognize the underlying asset • Profit recognition – Gain or loss on the transfer of the right to use asset‐ calculated as the difference between the present value of the lease payments to be received and the carrying value allocated to the right to use asset sold – Interest income and profit from the accretion of the residual asset recognized over the lease term Two Models for the Balance Sheet and Income Statement 2. Operating Lease Approach (Type B) • Most land and building leases • Lessor would keep property, plant & equipment on balance sheet

FASB Proposed Model

Lessor Accounting • Rental income would be recognized over the lease term on the straight line basis

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Transition

•Likely to be effective no earlier than Jan 1, 2017 •Companies will be required to restate comparative periods. •All existing operating leases will need to be re‐

FASB Proposed Model

g p g evaluated to comply with new standard •Existing Capital leases do not need to be re‐ evaluated.

2014 Update

•The Boards will continue re‐deliberations of the EDs during the second half of 2014 and expect to discuss the following issues: •Sale and lease‐back transactions;

FASB Proposed Model

•Small‐ticket leases; •Disclosures; •Leveraged leases (FASB only); •Private company and not‐for‐profit issues (FASB only);

2014 Update

• Chairman of the FASB suggested the standard would not be issued until the latter half of 2015.

FASB Proposed Model

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THANK YOU