THE NEW LEASE ACCOUNTING STANDARD

Transcription

1 THE NEW LEASE ACCOUNTING STANDARD May 30, 2018 BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms.

2 CPE AND SUPPORT CPE Participation Requirements To receive CPE credit for this webcast: You ll need to actively participate throughout the program. Be responsive to at least 75% of the participation pop-ups. Certificate of Attendance: If you are logged on for the entire time and respond to the requisite participation pop-ups, you will be able to print your certificate from the Participation section at the end of the webcast. If you log out before printing your certificate: Clients and Contacts and all other individual participants You will be ed instructions on how to access your certificate. Group participants will be ed a copy of their certificate within 30 days of submitting a group sign-in sheet. BDO USA professionals CPE will automatically be issued in CPE Tracking & Reporting. A copy of your certificate will be sent after you have been issued credit. 2

3 CPE AND SUPPORT (CONTINUED) Group Participation To receive credit: Sign-in sheets must list a Proctor name and CPA license number. Clients and contacts sign-in sheets to cpe@bdo.com within 24 hours of the webcast. BDO Alliance USA Should proctor their own group participants. This process is detailed in the LearnLive Participant Guide on the Alliance Portal. Call LearnLive Support for questions BDO International Unfortunately, we cannot currently support group CPE for International Firms. Those wanting CPE must register and log in on their own computer. BDO USA Submit your sign-in sheets using a General Learning & Development Request in BDO Service Now found at: > A to Z > BDO Service Now > Click Request in the upper right menu, then choose Learning & Development from the Filter Category drop-down, click on Learning & Development Support. 3

4 With You Today ANGELA NEWELL National Accounting Partner 600 N. Pearl St. Suite 1800 (214) JIN KOO National Accounting Partner 600 N. Pearl St. Suite 1800 (214)

5 LEARNING OBJECTIVES Upon completion of this program, participants will be able to: Identify the main provisions of the new lease standard as contrasted with prior accounting requirements Identify financial statement presentation and disclosures required by the new lease standard Recognize operational impact of the new standard 5

6 AGENDA Introduction Scope and Identifying a Lease Lease Classification and Payments Lessee Accounting and Presentation Lessor Accounting and Presentation Sale-Leaseback Transactions Disclosures Transition 6

7 Introduction The New Leasing Standard 7

8 Introduction ASU , Leases (Topic 842) issued February 2016 Dual approach for lessees and lessors Effective dates (early adoption permitted): Public Business Entities All Other Entities FYs beginning after 12/15/18 (and interim periods within) FYs beginning after 12/15/19 (interim periods within FYs beginning after 12/15/20) 8

9 Introduction Lessees Right of use model recognize ROU asset and lease liability at inception for all leases Optional exemption for leases with terms < 12 months Classify all leases as finance or operating (5 criteria) Finance lease lessee effectively obtains control of underlying asset Operating lease lessee does not effectively obtain control of underlying asset Similar balance sheet impact; different income statement and cash flow results 9

10 Introduction Lessors Classify all leases as sales-type, direct finance, or operating (similar to existing U.S. GAAP) based on same criteria as lessees, plus a few others Sales-type lease - transfers all risks and rewards, plus control of underlying asset, to lessee Direct financing transfers risks and rewards but not control Operating does not transfer risks and rewards or control Subsequent accounting is consistent with existing U.S. GAAP* Control principle aligned with new revenue standard * Leveraged lease treatment no longer available for new leases 10

11 Scope and Identifying a Lease The New Leasing Standard 11

12 Scope Applies to all leases and subleases, except: Leases of intangible assets (Topic 350) Leases for exploration or use of certain natural resources (Topics 930 & 932) Leases of biological assets (Topic 905) Leases of inventory (Topic 330) Leases of assets under construction (Topic 360) Scope exception for short-term leases (term less than 12 months) Separation of non-lease components 12

13 Identifying a Lease Lease A contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration Determine at inception based upon: Whether contract fulfillment depends on use of an identified asset* Whether contract conveys right to control use of identified asset for consideration for a time period * Consider whether supplier has substantive right of substitution 13

14 Identifying a Lease Right to control use of the identified asset depends upon: Right to obtain economic benefits from the use of the identified asset (e.g., through using, holding, or subleasing the asset). Economic benefits is fairly broad Consider within defined scope of customer s contractual right to use the asset Right to direct the use of an identified asset. This exists when customer has the right to direct how and for what purpose the asset is used, including the right to change how and for what purpose the asset is used, throughout the period of use. 14

15 Multiple Arrangements Contract combinations: multiple contracts should be combined when entered into with the same counterparty if: The contracts are negotiated as a package The price in one depends on the other Underlying assets conveyed by the contracts are a single lease component Non-lease components: if an arrangement contains both lease and nonlease components, they must be accounted for separately Lessees can elect a practical expedient to combine and account for as one lease FASB has proposed a similar practical expedient for lessors 15

16 Lease Classification and Payments The New Leasing Standard 16

17 Lease Classification Five criteria for finance lease (lessee) / sales-type lease (lessor): 1. Transfer of ownership of underlying asset to lessee by end of lease term 2. Option to purchase underlying asset that lessee is reasonably certain to exercise 3. Lease term = major part of remaining economic life of underlying asset 4. Sum of PV lease payments and PV any residual value guaranteed by lessee substantially all of the FV of underlying asset 5. Underlying asset is of such a specialized nature that it is expected to have no alternative use to lessor at end of lease term If one or more of the above are met, classify as finance/sales-type lease. 17

18 Lease Classification When none of the first five criteria are met, two other criteria for direct financing classification should be evaluated (lessor): 1. PV of lease payments + residual value guarantee by third party equals or exceeds substantially all of underlying asset FV. 2. It is probable that lessor will collect lease payments plus residual value guarantee. Both of the above criteria must be met for a lessor to classify as direct financing. Otherwise, classify as an operating lease. 18

19 Short-Term Leases Two criteria for short-term leases: Lease term of 12 months or less No option to purchase underlying asset that lessee is reasonably certain to exercise If short-term lease, lessee can elect not to apply recognition requirements (no balance sheet gross-up for ROU asset and related lease liability) Recognize lease payments in P&L on straight-line basis Recognize variable lease payments as they are incurred Accounting policy must be made by class of underlying asset and be disclosed 19

20 Lease Term and Payments Two elements form basis for PV of lease payments: Lease Term Lease Payments (Rentals) Estimated as the non-cancellable period of the lease Fixed lease payments (less incentives to be paid by lessor) Include periods under option to extend IF lessee is reasonably certain to exercise option Include periods under option to terminate IF lessee has is reasonably certain NOT to exercise option Same analysis for purchase options Variable payments tied to an index Variable payments which are in-substance fixed payments Residual value guarantees (probable amount) Exercise price of purchase option IF lessee is reasonably certain to exercise option Termination penalties IF lease term reflects lessee exercising option Fees paid to structure an SPE 20

21 Lease Term Reasonably certain is a high threshold substantially the same as reasonably assured in existing U.S. GAAP. Includes assessment of economic incentives. Reassess the lease term only upon the occurrence of a significant event or change in circumstances that are within the control of the lessee. 21

22 Lease Payments Variable payments: Day 1 - include index-based payments (e.g., CPI escalator) measurement based on the rate at commencement. Day 2 - only reassess when the lease liability is reassessed for other reasons (e.g., contract modification). Otherwise, changes in the index are period expenses. In-substance fixed payments are included in Day 1 lease liability, consistent with current practice. Discount rate - use the rate implicit in the lease if determinable, otherwise use incremental borrowing rate. Nonpublic entities policy election to use risk-free rate 22

23 Initial Direct Costs Include: Commissions Payments made to an existing tenant as an incentive to terminate its lease Do not include costs to negotiate or arrange a lease that would have been incurred regardless of whether the lease was obtained, such as: General overhead costs Examples: depreciation, occupancy and equipment costs, unsuccessful origination efforts, and idle time Costs related to activities performed by the lessor for advertising, soliciting potential lessees, servicing existing leases, or other ancillary activities Costs related to activities that occur before the lease is obtained Examples: costs of obtaining tax or legal advice, negotiating lease terms and conditions, or evaluating a prospective lessee s financial condition 23

24 Lessee Accounting and Presentation The New Leasing Standard 24

25 Lessee Accounting 25

26 Lessee Accounting Presentation for LESSEES: Balance Sheet Income Statement All leases: Present separately* or within similar classes of assets and liabilities with proper disclosure *No co-mingling of finance and operating leases Finance: Display interest on lease liability and amortization of ROU asset consistently with other interest and amortization expenses (combine or separate) Operating: Display interest on lease liability together with amortization of ROU asset, within income from continuing operations 26

27 Lessee Accounting Presentation for LESSEES: Statement of Cash Flows Operating activities Interest on lease liability arising from finance leases* Payments arising from operating leases Variable lease payments and S/T lease payments not included in lease liability Financing activities Principal repayments on finance leases *the requirement is to present consistent with Topic 230, which generally will result in operating classification 27

28 Lease Modification Any change to contractual terms and conditions of a lease that was not part of the original terms and conditions of a lease New lease: additional right of use priced on a standalone basis Generally require adjustment to lease asset and liability without affecting P&L Exception is a reduction of the lease s scope which would reduce lease asset and liability proportionately, with any difference recognized in P&L Modified lease: change in terms with no additional right of use or additional right of use not consistent with standalone value Reassess classification as of date of modification 28

29 Lessor Accounting and Presentation The New Leasing Standard 29

30 Lessor Accounting Sales-Type Lease 30

31 Lessor Accounting Direct Financing Lease 31

32 Lessor Accounting Operating Lease 32

33 Lease Receivable Lease Receivable A lessor s right to receive lease payments arising from a sales-type lease or a direct financing lease plus any amount that a lessor expects to derive from the underlying asset following the end of the lease term to the extent that it is guaranteed by the lessee or any other third party unrelated to the lessor, measured on a discounted basis. Measure at present value, discounted using rate implicit in lease: 1. Future lease payments, and 2. Amount lessor expects to derive from residual asset guarantee 33

34 Collectibility Not Assured at Commencement Sales-type lease Do not derecognize underlying asset Defer selling profit Direct financing lease Treat as operating lease Operating Lease Lesser of straight line or lease payments collected 34

35 Sale-Leaseback Transactions The New Leasing Standard 35

36 SALE-LEASEBACK TRANSACTIONS ASC 842 simplifies requirements for sales accounting through reference to ASC 606 Deletes detailed continuing involvement guidance Must meet control criteria in 606 Replaces details and complexity with judgment Generally expect more transactions to qualify for sales accounting Note: Sale-leaseback accounting now also applies to lessors, so a failed sale-leaseback now results in the buyer-lessor recognizing a receivable rather than a fixed asset BDO Alliance USA Conference: THE NEW LEASE ACCOUNTING STANDARD

37 SALE-LEASEBACK TRANSACTIONS Do you have a sale? 1. Do you meet the criteria in ASC through 25-8 on existence of a contract? 2. Has control been transferred pursuant to ASC ? Factors to consider: a. Seller-lessee has a present right to payment b. Buyer-lessor has legal title to asset c. Seller-lessee has transferred physical possession of asset d. Buyer-lessor has significant risks and rewards of ownership e. Buyer-lessor has accepted the asset No one factor is determinative BDO Alliance USA Conference: THE NEW LEASE ACCOUNTING STANDARD

38 SALE-LEASEBACK TRANSACTIONS Do you have a sale? 3. Will the leaseback be classified as a finance lease (seller-lessee) or a sales-type lease (buyer-lessor)? Buyer-lessor has not obtained control no sales accounting 4. Does seller-lessee have an option to repurchase the asset, other than when: Exercise price is at fair value at time of exercise Substantially the same alternative assets are readily available in the market would not apply to land/building BDO Alliance USA Conference: THE NEW LEASE ACCOUNTING STANDARD

39 SALE-LEASEBACK TRANSACTIONS Do you have a sale? - YES Seller-lessee: Recognize transaction price in accordance with guidance in ASC through Derecognize carrying amount of underlying asset Account for lease in accordance with ASC Buyer-lessor: Account for purchase in accordance with other GAAP Account for lease in accordance with ASC BDO Alliance USA Conference: THE NEW LEASE ACCOUNTING STANDARD

40 SALE-LEASEBACK TRANSACTIONS Do you have a sale? - NO Seller-lessee: Continue to recognize carrying amount of underlying asset Account for amounts received as financial liability in accordance with other GAAP Buyer-lessor: Do not recognize transferred asset Account for amounts paid as receivable in accordance with other GAAP BDO Alliance USA Conference: THE NEW LEASE ACCOUNTING STANDARD

41 Disclosures The New Leasing Standard 41

42 Disclosure Objectives To enable users of financial statements to assess Amount Timing and Uncertainty of cash flows arising from leases. 42

43 LESSEE DISCLOSURES Contractual details (lease term, contingent rentals, options, etc.) and related accounting judgments* Information about significant leases that have not yet commenced Information about lease liabilities separately for operating and finance leases: Maturity analyses of undiscounted lease payments Weighted-average remaining lease term Weighted-average discount rate Cash flows and supplemental noncash information Amounts related to lease cost (including any amounts capitalized) and related cash flows, separately for operating and finance leases If practical expedients related to short-term leases and separation of lease and non-lease components elected, disclose that fact and related details Format: No specific format required; ASU provides example in tabular format Judgment required to determine appropriate level of aggregation or disaggregation * Also disclose this information about subleases if applicable BDO Alliance USA Conference: THE NEW LEASE ACCOUNTING STANDARD

44 LESSOR DISCLOSURES Contractual details (lease term, contingent rentals, options, etc.) and related accounting judgments Narrative disclosures about leases (including information about variable lease payments and options) Tabular presentation of: Profit or loss at commencement (sales-type and direct financing) Interest income on receivables and residual assets (sales-type and direct financing) Lease income (operating) Maturity analysis of lease receivables (sales-type and direct financing) or lease payments (operating) Narrative disclosure about risk management for residual assets BDO Alliance USA Conference: THE NEW LEASE ACCOUNTING STANDARD

45 SAB 74 DISCLOSURES AT&T Q Q: In February 2016, the FASB issued ASU No , "Leases (Topic 842)," as modified (ASC 842), which replaces existing leasing rules with a comprehensive lease measurement and recognition standard and expanded disclosure requirements. ASC 842 will require lessees to recognize most leases on their balance sheets as liabilities, with corresponding "right-of-use" assets, and is effective for annual reporting periods beginning after December 15, 2018, subject to early adoption. For income statement recognition purposes, leases will be classified as either a finance or an operating lease without relying upon the bright-line tests under current GAAP. Upon initial evaluation, we believe the key change upon adoption will be the balance sheet recognition. At adoption, we will recognize a right-to-use asset and corresponding lease liability on our consolidated balance sheets. The income statement recognition of lease expense appears similar to our current methodology. We are continuing to evaluate the magnitude and other potential impacts to our financial statements BDO Alliance USA Conference: THE NEW LEASE ACCOUNTING STANDARD

46 SAB 74 DISCLOSURES American Airlines Group Q Q: Leases (Topic 842) (the New Lease Standard) The New Lease Standard requires lessees to recognize a lease liability and a right-of-use asset on the balance sheet and aligns many of the underlying principles of the new lessor model with those in the New Revenue Standard. The New Lease Standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. We will adopt the New Lease Standard effective January 1, We are currently evaluating how the adoption of the New Lease Standard will impact our consolidated financial statements. Interpretations are on-going and could have a material impact on our implementation. Currently, we expect that the adoption of the New Lease Standard will have a material impact on our consolidated balance sheet due to the recognition of right-of-use assets and lease liabilities principally for certain leases currently accounted for as operating leases BDO Alliance USA Conference: THE NEW LEASE ACCOUNTING STANDARD

47 SAB 74 DISCLOSURES Starbucks Q Q: In February 2016, the FASB issued guidance on the recognition and measurement of leases. Under the new guidance, lessees are required to recognize a lease liability, which represents the discounted obligation to make future minimum lease payments, and a corresponding right-of-use asset on the balance sheet for most leases. The guidance retains the current accounting for lessors and does not make significant changes to the recognition, measurement, and presentation of expenses and cash flows by a lessee. Enhanced disclosures will also be required to give financial statement users the ability to assess the amount, timing and uncertainty of cash flows arising from leases. The guidance will require modified retrospective application at the beginning of our first quarter of fiscal 2020, with optional practical expedients, but permits adoption in an earlier period. We are currently evaluating the impact this guidance will have on our consolidated financial statements. We expect this adoption will result in a material increase in the assets and liabilities on our consolidated balance sheets but will likely have an insignificant impact on our consolidated statements of earnings. In preparation for the adoption of the guidance, we are in the process of implementing controls and key system changes to enable the preparation of financial information BDO Alliance USA Conference: THE NEW LEASE ACCOUNTING STANDARD

48 SAB 74 DISCLOSURES American Tower Corp Q Q: In February 2016, the FASB issued new guidance on the accounting for leases. The guidance amends the existing accounting standards for lease accounting, including the requirement that lessees recognize right of use assets and lease liabilities for leases with terms greater than twelve months in the statement of financial position. Under the new guidance, lessor accounting is largely unchanged. This guidance is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, The Company (i) has established a multidisciplinary team to assess and implement the new guidance, (ii) expects the guidance to have a material impact on its consolidated balance sheets due to the recording of right of use assets and lease liabilities for leases in which it is a lessee and which it currently treats as operating leases and (iii) continues to evaluate the impact of the new guidance BDO Alliance USA Conference: THE NEW LEASE ACCOUNTING STANDARD

49 Transition The New Leasing Standard 49

50 Transition Lessee & lessor transition Modified retrospective approach with hindsight allowed for evaluating renewal and purchase options on existing leases. No option for full retrospective. Significant relief provisions allowed as a policy election No reassessment of: Whether any expired or existing contracts are or contain leases Classification for any expired or existing leases Initial direct costs for expired or existing leases Leveraged lease treatment grandfathered Sale-leaseback transition No reassessment of initial sale/leaseback conclusions Specific transition for deferred gains (or losses) related to capital or operating leases 50

51 Transition Considerations Developing a plan to transition, including impacts on: ICFR Planning and budgeting Taxes Compensation arrangements Debt covenants and other contracts Internal and external communication IT systems/data management Lease structure strategy 51

52 IMPLEMENTATION CONSIDERATIONS WHAT DO I DO FIRST? Inventory existing leases what is the source for your five-year maturities table? Determine existing system resources Do you currently use a lease management system? Does that system currently have the ability to account for rent expense on a straight-line basis (whether or not you are using it)? Have you talked to the vendor about their plans to become compliant with the new standard? If no system in place, determine whether you need to implement one How many leases and how complex? Other stakeholders (facilities management, etc.) Budget constraints BDO Alliance USA Conference: THE NEW LEASE ACCOUNTING STANDARD

53 IMPLEMENTATION CONSIDERATIONS AND THEN WHAT? Talk to lease management team Explain provisions of standard Talk to CFO/Finance team If enter into long-term leases, consider whether finance lease treatment would be a better result (P&L impact outside EBITDA) If so, communicate change in lease strategy to lease negotiators Consider other stakeholders and their needs Review debt covenants for lease treatment, communicate with Treasury team Discuss impact of any change in lease negotiation strategy with investor relations and HR (consider impact to bonus plans) BDO Alliance USA Conference: THE NEW LEASE ACCOUNTING STANDARD

54 IMPLEMENTATION CONSIDERATIONS I VE CHOSEN A SYSTEM, NOW WHAT? Work with IT to finalize an implementation plan Ensure appropriate connectivity with general ledger and AP modules Consider testing procedures, identify testing team Work with Internal Audit to update controls documentation Consider implementation controls, both from an accounting and an IT perspective Document new control environment post implementation Determine transition approach Transition practical expedients may result in lack of comparability between accounting for pre-existing leases vs. new leases entered into post-adoption BDO Alliance USA Conference: THE NEW LEASE ACCOUNTING STANDARD

55 Questions? 55

56 RESOURCES / REFERENCES BDO Knows: Topic 842, Leases surance/fasb/fasb-newsletterjuly-2016 BDO Knowledge Webinar (Self study): e-new-lease-accountingstandard BDO Alert: surance/fasb/fasb-flash-reportmarch

57 CONCLUSION Thank you for your participation! Certificate Availability If you participated the entire time and responded to at least 75% of the polling questions, click the Participation tab to access the print certificate button. Please exit the interface by clicking the red X in the upper right hand corner of your screen. 57

58 Appendix - Examples The New Leasing Standard 58

59 Identifying a Lease: Fiber Optic Cables Customer enters into a 15-year contract with a utilities company (Supplier) for the right to use three specified, physically distinct dark fibers within a larger cable connecting New York to London. Customer makes all of the decisions about the use of the fibers by connecting each end of the fibers to its electronics equipment (i.e. Customer lights the fibers). The arrangement contains a lease. 59

60 Identifying a Lease: Fiber Optic Cables Customer enters into a 15-year contract with Supplier for the right to use a specified amount of capacity within a cable connecting New York to London. The specified amount is equivalent to Customer having the use of the full capacity of three fiber strands within the cable (the cable contains 15 fibers with similar capacities). The arrangement does NOT contain a lease. 60

61 Lease Term and Payments: Retail Store Retailer enters into a 5-year lease agreement with a mall operator that includes three 5-year renewal options. Rent payments are $5,000/month plus 1% of sales during the initial term, with base rent growing 10% in each renewal period. Retailer incurs costs of $100,000 installing leasehold improvements to customize space to its brand requirements. LHI has a useful life of 8 years. 61

62 Lease Term and Payments: Retail Store The existence of significant leasehold improvements with a useful live longer than the base lease term indicates that Retailer would incur an economic loss from not exercising the first renewal option. Lease term is 10 years, base term plus one renewal period. Percentage rent is variable, and thus is not included in lease payments. Instead expensed as incurred. Lease payments total $630,000 ($300k for base + $330k for renewal). 62

63 Lessee Accounting Example Facts: 10-year lease, option to extend 5 years LP = $50K/year (initial term); $55K/year (optional period) Not reasonably certain to exercise option to extend, therefore, lease term = 10 years Payments due at beginning of each year Initial direct costs (IDC) = $15K Lessee s incremental borrowing rate = 5.87% PV of remaining LP after payment of 1 st year rental & IDC = $342,017 63

64 Lessee Accounting Example (Continued) Journal entry to record lease assets & liabilities at commencement: Right-of-use asset 407,017 Lease liability 342,017 Cash (lease payment for year 1) 50,000 Cash (initial direct costs) 15,000 64

65 Lessee Accounting Example (Continued) Journal entry to recognize lease expense during 1 st year, if finance: Interest expense 20,076 1 Lease liability 20,076 Amortization expense 40,702 2 Right-of-use asset 40, Calculated as (5.87% 342,017) 2. Calculated as (407,017 10) 65

66 Lessee Accounting Example (Continued) Journal entry to recognize lease expense during 1 st year, if operating: Lease expense 51,500 1 Lease liability 20,076 2 Right-of-use asset 31, Calculated as [(500,000+15,000) 10] 2. Calculated as (5.87% 342,017) 3. Calculated as (51,500-20,076) 66

67 Lessee accounting example (Continued) Total lease expense recognized over life of lease Finance vs. Operating (in $000s, approximate) Finance Operating 10 0 Year 1 Year 9 67

68 Lease Modification: Office Space A company leases one floor of an office building, which it uses to house its headquarters. The lease commences on 1/1/2016, has a term of 10 years, and a price of $70/ft 2. The company experiences tremendous growth, so that on 1/1/2018, it modifies the lease to include an additional 6,000 ft 2 on a second floor of the building. The price for the new space is $80/ft 2, the then current market price. The term remains unchanged. The modification results in a new lease. Recognize new ROU asset and lease liability. 68

69 Lease Modification: Office Space Same facts as last example, except that the lease was modified to reprice the entire space (existing floor plus new 6,000 ft 2 ) at $75/ ft 2, and the term of the combined lease was extended for an additional five years. The modification results in a modified lease. Remeasure lease liability on 1/1/2018 based on the new terms. Recognize difference between remeasured lease liability and carrying value of existing lease liability as adjustment to ROU asset. Operating or finance classification should also be reassessed. 69

70 SALE-LEASEBACK TRANSACTIONS Facts: Seller sells asset to unrelated buyer for cash of $2M Immediately before transaction asset had carrying value of $1.8M and remaining useful life of 21 years At same time, seller enters into contract with buyer to lease back the asset for 8 years with annual payments of $200,000 in arrears Contract includes option for seller to repurchase asset at end of year 5 for $800,000 Seller s incremental borrowing rate is 4% Existence of fixed price repurchase option precludes sales accounting 70

71 SALE-LEASEBACK TRANSACTIONS Accounting treatment: Seller-lessee at inception: Dr. Cash $2,000,000 Cr. Financing liability $2,000,000 Buyer-lessor at inception: Dr. Financing receivable $2,000,000 Cr. Cash $2,000,000 71

72 SALE-LEASEBACK TRANSACTIONS Accounting treatment: Seller-lessee subsequent to initial recognition: End of Year 1: Dr. Interest expense $84,600* Dr. Financing liability $115,400 Cr. Cash $200,000 Dr. Depreciation expense $85,714** Cr. Accumulated depr $85,714 *Interest expense calculated based on imputed interest rate of 4.23% to ensure that carrying amount of asset will not exceed financial liability at end of year 5 when repurchase option expires. ** Asset continues to depreciate over remaining life of 21 years. 72

73 SALE-LEASEBACK TRANSACTIONS Accounting treatment: Buyer-lessor subsequent to initial recognition Dr. Cash $200,000 Cr. Financing receivable $120,000 Cr. Interest income $80,000* *Buyer continues to use seller s incremental borrowing rate to recognize interest expense as this represents a market rate.. 73

74 SALE-LEASEBACK TRANSACTIONS Facts, end of year 5: Repurchase option expires unexercised No other factor precludes sales accounting treatment Leaseback classified as operating lease Seller-lessee derecognizes asset and financing liability, recognizes ROU asset and lease liability Buyer-lessor derecognizes lease receivable, recognizes asset 74

75 SALE-LEASEBACK TRANSACTIONS Accounting treatment: Seller-lessee at end of year 5: Dr. Financing liability $1,372,077 Cr. Asset $1,371,429 Cr. Gain on sale $648 Dr. ROU asset $555,018 Cr. Lease liability $555,018* * Present value of annual lease payments of $200,000 for remaining lease term (3 years) discounted at incremental borrowing rate at inception of lease of 4% 75

76 SALE-LEASEBACK TRANSACTIONS Accounting treatment: Buyer-lessor at end of year 5: Dr. Asset $1,350,041 Cr. Lease receivable $1,350,041 76