Brad Bonde, CPA Senior Manager, HC Services/Audit & Advisory

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1 Brad Bonde, CPA Senior Manager, HC Services/Audit & Advisory

2 Overview Background Improving Lease Accounting Scope Accounting Models Disclosures Effective Dates 2

3 Background Source - FASB 3

4 QUIZ What amount of Off-Balance Sheet Operating Lease Commitments for SEC registrants were there in 2005? A. $1.25 MILLION B. $1.25 BILLION C. $1.25 TRILLION 4

5 ANSWER C TRILLION Source - FASB 5

6 Improving Lease Accounting How will the new lease standard improve lease accounting? Results in a more faithful representation of a lessee s rights and obligations arising from leases Results in fewer opportunities for organizations to structure leasing transactions to achieve a particular outcome on the balance sheet Improves understanding and comparability of lessee s financial statements Aligns lessor accounting and sale and leaseback transaction guidance more closely to comparable revenue guidance in the new revenue recognition standard Provides users of financial statements with additional information about lessors leasing activities and lessors exposure to credit and asset risk as a result of leasing Clarifies the definition of a lease to address practice issues within current GAAP and to align concept of control, as used within the definition, more closely with control principle used in revenue recognition and consolidations Source - FASB 6

7 Scope Who is affected? The new lease standard affects all companies or other organizations that lease assets such as real estate, airplanes, ships, and construction and manufacturing equipment. Source - FASB 7

8 New Guidance Under the new lease standard, all lessees will recognize assets and liabilities for leases with lease terms of more than 12 months. Companies will record an asset related to the right to use the leased asset and a liability related to the lease obligation. 8

9 Right-of-Use Source - FASB 9

10 Scope Identifying a Lease Source - FASB 10

11 Accounting Models Source - FASB 11

12 Example Overview Sales Type Lease (from Lessor perspective) Customer contracts with Supplier to lease purification equipment over a five-year period and purchases disposable tablets and filters (disposables) used in operation of the equipment. The equipment has an estimated 5 year life, no residual value, and the standalone sales price is $150,000 (cost basis of $100,000). Contracted to sale disposables during the lease for $10 (cost basis of $5), which is not considered the standalone sales price of each disposable (est. at $12). Standalone price (A) Relative % (A /total) = (B) Payment (C) Allocated lease payment (B x C) Purification equipment $150, % $40,000 $28,600 Estimated disposables sold over contract term (1,000 per year for 5 years) 60, % 40,000 11,400 Total $210, % $40,000 12

13 How should Supplier account for this arrangement (commencement and first year) The equipment lease and sale of disposables are separate lease and nonlease components, respectively. The variable payments relate specifically to the nonlease component (sale of disposables) because the sale of disposables is not related to the usage of the leased purification equipment. In this example, we are assuming that Supplier allocates the variable payments to the lease and nonlease components. However, if a lessor believes that allocating the variable consideration entirely to the nonlease component is consistent with the allocation objective in ASC , then it should do so. 13

14 How should Supplier account for this arrangement (commencement and first year) Since the lease is a sales-type lease, Supplier would remove the asset from its balance sheet and record a receivable equal to the present value of the lease payments. The lease receivable is $142,857, calculated as ($150,000 total fixed payments + $50,000 estimate of variable consideration for disposables) ($150,000 selling price of equipment $210,000 combined selling price of equipment and disposables). For simplicity, discounting has been ignored in this example. 14

15 How should Supplier account for this arrangement (commencement of lease) Supplier would record the following journal entry at the beginning of the lease: Dr. Lease receivable $142,857 Dr. Cost of sales $100,000 Cr. Revenue $142,857 Cr. Inventory $100,000 15

16 How should Supplier account for this arrangement (first year) (carryforward from prior slide) Standalone price (A) Total $210, % $40,000 Supplier would record the following journal entries during the first year of the lease: Dr. Cash $40,000 Cr. Lease receivable $28,600 Cr. Sales revenue $11,400 Dr. Cost of sales $5,000 Relative % (A /total) = (B) Payment (C) Allocated lease payment (B x C) Purification equipment $150, % $40,000 $28,600 Estimated disposables sold over contract term (1,000 per year for 5 years) 60, % 40,000 11,400 Cr. Inventory $5,000 16

17 Accounting Models Source - FASB 17

18 Lessee Lease Classification Criteria Does the lease transfer ownership of the underlying asset to the lessee by the end of the lease term? Does the lease grant the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise? Is the lease term for a major part of the remaining economic life of the underlying asset? Is the present value of the sum of the lease payments and any residual value guaranteed by the lessee, that is not otherwise included in the lease payments, substantially all of the fair value of the underlying asset? Is the underlying asset of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term? If YES to ANY, it is a Financing Lease If NO to ALL, it is an Operating Lease 18

19 Example Overview - Finance Lease (from lessee s perspective) Customer contracts with Supplier to lease purification equipment over a five-year period and purchases disposable tablets and filters (disposables) used in operation of the equipment. The equipment has an estimated 5 year life, no residual value, and the standalone sales price is $150,000 (cost basis of $100,000). Contracted to sale disposables during the lease for $10 (cost basis of $5), which is not considered the standalone sales price of each disposable (est. at $12). Standalone price (A) Relative % (A /total) = (B) Payment (C) Allocated lease payment (B x C) Purification equipment $150, % $40,000 $28,600 Estimated disposables sold over contract term (1,000 per year for 5 years) 60, % 40,000 11,400 Total $210, % $40,000 19

20 Example Overview - Finance Lease (from lessee s perspective) Additional Information: First annual payment of $30,000 is due at execution of the lease. Customer incurs $5,000 of initial direct costs, which are payable at execution. Customer calculates the initial lease liability at present value of the lease payments discounted using their incremental borrowing rate as the implicit rate is not readily available of $135,000. Initial measurement of lease liability $135,000 Initial direct costs 5,000 Initial measurement of rightof-use asset $140,000 20

21 How should Customer account for this arrangement Finance Lease (from lessee s perspective) Customer would record the following journal entry at the beginning of the finance lease: Dr. Right-of-use asset $135,000 Cr. Lease liability $135,000 Dr. Right-of-use asset $5,000 Cr. Accrued expense / cash $5,000 For each subsequent period, Customer would amortize the Right-of-use asset over the shorter of the lease term (5 years) or the useful life of the asset and recognize interest expense under the interest method (7%). Dr. Amortization expense $28,000 Cr. Right-of-use asset $28,000 Dr. Interest expense $9,400 Dr. Lease liability $20,600 Cr. Cash $30,000 21

22 Operating Lease Example Lessee Corp leases an automobile from Lessor Corp. The following table summarizes information about the lease and the leased asset: Source PwC Lease Accounting Guide 22

23 Operating Lease Example - Continued This lease is classified as an operating lease as none of the criteria for finance lease classification are met. The right-of-use asset and lease liability are $16,518. Source PwC Lease Accounting Guide 23

24 Operating Lease Example - Continued How would Lessee Corp measure the right-ofuse asset and lease liability over the lease term? Analysis: Lessee Corp is required to pay $500 per month for three years, so the total lease payments are $18,000 ($500 x 36 months). Lessee Corp would then calculate the straight-line lease expense to be recorded each period by dividing the total lease payments by the total number of periods. The monthly straight-line expense are equal as the lease does not contain any escalation provisions or other required or optional payments. Lessee Corp would calculate the amortization of the lease liability as shown on the table on the following page. This table is shown on an annual basis for simplicity; the schedule would be calculated on a monthly basis to reflect the frequency of the lease payments. Source PwC Lease Accounting Guide 24

25 Operating Lease Example - Continued Source PwC Lease Accounting Guide 25

26 Operating Lease Example - Continued The amortization of the right-of-use asset is calculated as the difference between the straight-line lease expense and the interest expense on the lease liability. The following table shows this calculation. This table is shown on an annual basis for simplicity; the schedule would be calculated on a monthly basis to reflect the frequency of the lease payments. Source PwC Lease Accounting Guide 26

27 Lessee Disclosures Source - FASB 27

28 Lessor Disclosures Source - FASB 28

29 Effective Dates New guidance is effective for fiscal years beginning after December 15, 2018 for the following: A public business entity A not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed or an over-the-counter market An employee benefit plan that files financial statements with the U.S. Securities and Exchange Commission (SEC) For all other organizations, the new guidance is effective for fiscal years beginning after December 15, Early application is permitted for all organizations. Source - FASB 29

30 Questions & Comments Brad Bonde Senior Manager, HC Services/Audit & Advisory