The new accounting standard for leases. 27 March 2017

Transcription

1 The new accounting standard for leases 27 March 2017

2 Disclaimer Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a clientserving member firm of Ernst & Young Global Limited located in the US. This presentation is 2017 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party. Views expressed in this presentation are those of the presenters and not necessarily those of Ernst & Young LLP. This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice. Page 2

3 Objectives Provide an overview of Accounting Standards Codification (ASC) 842, Leases Summarize what changes you can expect to see in the financial statements of most utilities as a result of their adoption of ASC 842 Discuss implications for regulators Answer your questions Page 3

4 Overview of new lease standard Effective 1/1/19 for public companies, early adoption permitted Q Exposure draft (ED) Re-deliberations and second ED Re-deliberations on second ED Q Final standard Key changes affecting lessees Requires most leases to be recorded on the balance sheet, but expenses are recognized in a manner similar to today. Eliminates real estate-specific provisions. Provides new presentation and disclosure requirements Changes sale and leaseback criteria, and they apply to lessees and lessors Certain concepts aligned with the new revenue recognition standard Key changes affecting lessors Modifies classification criteria and accounting for sales-type and direct financing leases Eliminates leveraged leases prospectively Page 4

5 Overview Right-of-use model Right to use an identified asset Lessee Financial obligation to make lease payments Lessor Lease classification Lease classification Finance Operating Salestype Direct financing Operating Recognize right-of-use (ROU) assets and lease liabilities for most leases Recognize expense similar to legacy GAAP Similar to legacy GAAP with some changes Leveraged lease accounting eliminated prospectively Page 5

6 Effective date and transition SAB Topic 11.M Effective Final leases standard and early adoption permitted Prior periods presented Modified retrospective application (public entities*) Prior periods presented Modified retrospective application (all other entities) * Public entities includes public business entities and certain not-for-profit entities and employee benefit plans Certain practical expedients are available for transition Full retrospective adoption is prohibited Certain disclosures are required in accordance with ASC 250, Accounting Changes and Error Corrections Page 6

7 Scope and scope exceptions A lease is 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. The standard applies to leases of property, plant and equipment It does not apply to: Leases of inventory, assets under construction, intangible assets and biological assets, including timber Leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources Page 7

8 Scope and definition of a lease Legacy GAAP The new leases standard An asset is identified explicitly or implicitly. Guidance does not address substitution rights. Guidance says that there is no identified asset if the supplier has a substantive substitution right. The customer has the right to control the use of the identified asset Any one of the following criteria is met: The customer operates the PP&E. The customer controls physical access to the PP&E. It is remote that other parties will take more than a minor amount of the output, and certain pricing criteria are met. The customer has both: The right to substantially all the economic benefits from the use of the identified asset throughout the period of use. The right to direct how and for which purpose the asset is used throughout the period of use. Page 8

9 Determining whether an arrangement contains a lease Is there an identified asset? No Yes Does the customer have the right to obtain substantially all of the economic benefits from the use of the identified asset throughout the period of use? No Customer Does the customer or supplier have the right to direct how and for what purpose the identified asset is used throughout the period of use? Yes Neither; how and what purpose is predetermined Supplier Yes Does the customer have the right to operate the asset throughout the period of use without the supplier having the right to change those operating instructions? No Yes Did the customer design the asset (or specific aspects of the asset) in a way that predetermines how and for what purpose the asset will be used throughout the period of use? No No The contract is or contains a lease The contract is not or does not contain a lease Page 9

10 Scope and definition of a lease Example: fact pattern A utility company (Customer) enters into a contract with a power company (Supplier) to purchase all of the electricity produced by its wind farm for 20 years and available renewable energy credits. Supplier designed and constructed the wind farm. Supplier has no substitution right. Customer cannot determine or change the amount of output during the contract. Customer will pay a fixed capacity charge and a variable charge based on actual production. Supplier operates and maintains the wind farm and retains certain rights to protect its interest in the wind farm. Page 10 EY s Baltimore Technical Update

11 Scope and definition of a lease Applying the definition of a lease what is changing? Legacy GAAP Contract contains a lease. The new leases standard Contract does not contain a lease. An asset is identified explicitly. Customer has the right to control the use of the identified asset. It is remote that another party will take more than a minor amount of the facility s output, and the price that Customer will pay meets certain criteria. Customer does not have the right to control the use of the identified asset. Customer has the right to obtain substantially all the economic benefits from the use of the wind farm. Customer does not have the right to direct how and for what purpose the wind farm is used. Page 11 EY s Baltimore Technical Update

12 Lessee accounting recognition and measurement Initial recognition and measurement Finance leases Operating leases Initially measures the ROU asset 1 and lease liability at the present value of the lease payments to be made over the lease term Subsequent measurement lease liability Subsequent measurement ROU asset Accretes the lease liability based on the interest method using the discount rate determined at lease commencement 2 and reduces the lease liability by the payments made Amortizes the ROU asset, generally on a straight-line basis over the shorter of lease term or the useful life of the ROU asset and records any impairment of the ROU asset Measures the lease liability at the present value of remaining lease payments using discount rate determined at lease commencement 2 Measures the ROU asset at the amount of remeasured lease liability, adjusted for the remaining balance of any lease incentives received, any cumulative prepaid or accrued rents (i.e., uneven rent payments), any unamortized initial direct costs and any impairment of the ROU asset Income statement effect Generally front-loaded expense Generally straight-line expense 1 Initial measurement of the ROU asset also includes the lessee s initial direct costs and prepayments made to the lessor at or before the commencement date, less lease incentives received from the lessor. 2 As long as the discount rate has not been updated as a result of a reassessment event. Page 12

13 Lessee accounting short-term leases Lessees can make an accounting policy election, by class of underlying asset to which the right of use relates, to use the short-term lease exception Applies to leases with a lease term of 12 months or less that do not include an option to purchase the underlying asset that the lessee is reasonably certain to exercise Lessees do not recognize a ROU asset or lease liability for qualifying leases and recognize lease payments as expense on a straight-line basis Exception is not available for lessors Example: noncancellable lease term of nine months with a four-month renewal option (assume no purchase option) A: Exercise of option is reasonably certain = not short-term lease Nine months Four months B: Exercise of option is not reasonably certain = short-term lease Nine months Noncancelable lease term Four months Optional renewal period Page 13

14 Lease classification lessees At lease commencement, lessees classify a lease as a finance lease if the lease meets any of the following criteria: The lease transfers ownership of the underlying asset to the lessee by the end of the lease term The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise The lease term is for the major part of the remaining economic life of the underlying asset* The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments equals or exceeds substantially all of the fair value of the underlying asset The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of lease term * Not applicable for leases that commence at or near the end of the underlying asset s economic life. Page 14

15 Review of FERC reporting for leases Lease classification Uniform System of Accounts for both Electric and for Natural Gas includes the following definitions Lease, capital means a lease of property used in utility or nonutility operations, which meets one or more of the criteria stated in General Instruction 19. Lease, operating means a lease of property used in utility or nonutility operations, which does not meet any of the criteria stated in General Instruction 19. The criteria in General Instruction 19 are consistent with the current capital lease criteria transfer of ownership, bargain purchase option, 75% of useful life or payments 90% of value. Page 15

16 Lease term and purchase options Any noncancellable periods Lease term Periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option Periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option Periods covered by an option to extend (or not terminate) the lease in which the exercise of the option is controlled by the lessor The FASB indicated that reasonably certain has the same meaning as reasonably assured in ASC 840, Leases Reasonably certain is generally interpreted as a high threshold Purchase options are assessed in the same way as options to extend the lease term or terminate the lease Page 16

17 Lease payments Lease payments should be consistent with the lease term determination Lease payments Fixed payments, including insubstance fixed payments, less any lease incentives paid or payable to the lessee Exercise price of a purchase option* Payments for penalties for terminating the lease** Variable lease payments that depend on an index or rate Amounts it is probable that the lessee will owe under residual value guarantees (lessees only) * Include only if reasonably certain of exercise ** Include unless reasonably certain that the lessee will not exercise an option to terminate the lease Also include fees paid by the lessee to the owners of a special-purpose entity for structuring the transaction Variable lease payments that do not depend on an index or rate (e.g., performance- or usage-based payments) are excluded from lease payments Recognize expense as incurred (lessees) or income as earned (lessors) Page 17

18 Discount rates Lessors use the rate implicit in the lease that causes the following: The present value (PV) of lease payments made by the lessee for the right to use the underlying asset The PV of the amount the lessor expects FV of the underlying asset minus + = any related + to derive from investment tax the underlying credit retained asset following and expected the end of the to be realized lease term by the lessor Any deferred initial direct costs of the lessor Lessees use their incremental borrowing rate when the rate implicit in the lease cannot be readily determined Lessees that are not PBEs are permitted to make an accounting policy election (for all leases) to use a risk-free rate determined using a period comparable with the lease term Page 18

19 Lessee accounting presentation ROU asset Lease ROU are assets presented either separately or together with other assets (e.g., owned assets) If presented together with other assets, disclose line items that include ROU assets and their amounts Finance lease ROU assets must be presented separately from operating lease ROU assets ROU assets are subject to same classification as other nonfinancial assets Balance sheet Lease liability Lease liabilities presented either separately or together with other liabilities If presented together with other liabilities, disclose the line items that include lease liabilities and their amounts Finance lease liabilities must be presented separately from operating lease liabilities Lease liabilities are subject to classification as current and noncurrent, similar to other financial liabilities Page 19

20 Lessee accounting presentation (cont.) Income statement Statement of cash flows Finance leases Lease-related amortization and lease-related interest expense presented in a manner consistent with how the entity presents depreciation or amortization of similar assets and other interest expense Operating lease Lease expense included in income from continuing operations Finance leases Principal payments within financing activities Interest payments in accordance with ASC 230, Statement of Cash Flows Operating leases All payments within operating activities, except for payments that represent costs to bring another asset to the condition and location necessary for its intended use (investing activities) Both lease types Lease payments for short-term leases and variable lease payments (not included in the lease liability) within operating activities Supplemental noncash disclosures Page 20

21 Review of FERC reporting for leases 20. Accounting for leases. A. All leases shall be classified as either capital or operating leases. The accounting for capitalized leases is effective January 1, 1984, except for the retroactive classification of certain leases which, in accordance with FASB No. 71, will not be required to be capitalized until after a three year transition period. For the purpose of reporting to the FERC, the transition period shall be deemed to end December 31, B. The utility shall record a capital lease as an asset in account 101.1, Property under Capital Leases, Account 120.6, Nuclear Fuel under Capital Leases, or account 121, Nonutility Property, as appropriate, and an obligation in account 227, Obligations under Capital Leases Noncurrent, or account 243, Obligations under Capital Leases Current, at an amount equal to the present value at the beginning of the lease term of minimum lease payments during the lease term, excluding that portion of the payments representing executory costs such as insurance, maintenance, and taxes to be paid by the lessor, together with any profit thereon. However, if the amount so determined exceeds the fair value of the leased property at the inception of the lease, the amount recorded as the asset and obligation shall be the fair value. Page 21

22 Review of FERC reporting for leases 20. Accounting for leases. D. Rental payments on all leases shall be charged to rent expense, fuel expense, construction work in progress, or other appropriate accounts as they become payable. E. For a capital lease, for each period during the lease term, the amounts recorded for the asset and obligation shall be reduced by an amount equal to the portion of each lease payment that would have been allocated to the reduction of the obligation, if the payment had been treated as a payment on an installment obligation (liability) and allocated between interest expense and a reduction of the obligation so as to produce a constant periodic rate of interest on the remaining balance. Page 22

23 Disclosure New disclosures for lessees and lessors include: Significant assumptions and judgments made in accounting Maturity analyses including a reconciliation of undiscounted cash flows to the lease liabilities for lessees, lease receivables of sales-type and direct financing leases for lessor, by type, as of the reporting date New disclosures for lessees include: Separate quantitative disclosure of lease expense, by type (e.g., financing lease, operating lease, short-term, variable) Weighted-average remaining lease term, separately by lease type Weighted-average discount rate, separately by lease type New disclosures for lessors include: Information about management of risks related to residual values of leased assets For sales-type and direct financing leases, explanations of significant changes in balance of unguaranteed residual assets Table of lease income recognized in each annual and interim reporting period Page 23

24 Today s presenters Angela Nagy Financial Accounting Advisory Services Atlanta, GA angela.nagy@ey.com Ron Stark Financial Accounting Advisory Services Philadelphia, PA ron.stark@ey.com Page 24

25 Appendix Additional background and topics, including lessor accounting and sale and leaseback transactions Page 25

26 Lease and non-lease components Contracts may contain a lease coupled with an agreement to purchase or sell other goods or services (non-lease components) Non-lease components are identified and accounted for separately from the lease component in accordance with other US GAAP As a practical expedient, lessees can make an accounting policy election (by class of underlying asset) to account for each separate lease component of a contract and its associated non-lease component(s) as a single lease component Lessees generally allocate consideration in the contract to the lease and nonlease components (unless the practical expedient is elected) on a relative standalone price basis Lessors generally apply ASC 606, Revenue from Contracts with Customers, to allocate consideration in the contract between the lease and non-lease component(s) of the contract on a relative standalone selling price basis Page 26

27 Initial direct costs (IDCs) Only incremental costs qualify as IDCs (consistent with ASC 606) Incremental costs are those that would not have been incurred if the lease had not been obtained (e.g., commissions, payments made to an existing tenant to incentivize that tenant to terminate its lease) Lease classification Accounting for capitalized IDCs Lessees Finance lease Include IDCs in the initial and subsequent measurement of the ROU asset Operating lease Lessors* Sales-type lease with selling profit or loss Sales-type lease with no selling profit or loss Direct financing lease with selling profit or loss Direct financing lease with no selling profit or loss Operating lease Expense IDCs at lease commencement Include IDCs in the initial and subsequent measurement of the net investment in the lease Recognize IDCs as expense over the lease term on the same basis as lease income * For purposes of performing the sales-type lease classification test only, a lessor assumes that no initial direct costs will be deferred (i.e., initial direct costs are excluded from the calculation of the rate implicit in the lease) if, at the commencement date, the fair value of the underlying asset is different from its carrying amount. Page 27

28 Lease classification lessors Does the lease meet any one of the classification criteria on page 11? No Does the lease meet both of the following criteria? The present value of the sum of lease payments and any residual value guaranteed by the lessee and any other third party unrelated to the lessor equals or exceeds substantially all the fair value of the underlying asset It is probable that the lessor will collect the lease payments plus any amounts necessary to satisfy a residual value guarantee Yes Yes No Sales-type lease* Direct financing lease Operating lease * ASC 842 does not require lessors to assess the collectibility of lease payments and any residual value guarantee provided by the lessee in the sales-type lease classification test. However, lessors are required to assess the collectibility of lease payments and any residual value guarantee provided by the lessee to determine the recognition and initial measurement of sales-type leases. Page 28

29 Lessor accounting initial recognition and measurement Sales-type leases Direct financing leases Operating leases Collectibility is probable Derecognizes underlying asset Recognizes net investment in the lease Derecognizes underlying asset Recognizes net investment in the lease Recognizes any selling loss Continues to recognize the underlying asset Collectibility assessment affects subsequent recognition (see page 20) Recognizes any selling profit or loss Collectibility is not probable Defers any selling profit and includes it in the initial measurement of net investment in the lease Does not derecognize underlying asset as sale is deferred Note: Initial collectibility assessment affects classification (see page 12) Page 29

30 Lessor accounting subsequent measurement Sales-type leases collectibility is probable Direct financing leases Recognizes interest income over the lease term in an amount that produces a constant periodic discount rate on the remaining balance of the net investment in the lease including: Interest on the lease receivable Accretion of the unguaranteed residual asset Amortization of any deferred selling profit (direct financing leases) Reduces net investment in the lease for lease payments received, net of interest income Separately recognizes income for variable lease payments that do not depend on an index or rate when the changes in facts and circumstances on which the variable lease payments are based occur Recognizes changes to variable lease payments that depend on an index or a rate in profit or loss in period of the change Recognizes any impairment of the net investment in the lease Page 30

31 Lessor accounting subsequent measurement (cont.) Sales-type leases collectibility is not probable Accounts for the underlying asset under other US GAAP (e.g., depreciates the asset) Recognizes lease payments and variable lease payments that do not depend on an index or rate received as a deposit liability until the earlier of: Collection of the lease payments, plus any amount necessary to satisfy a residual value guarantee provided by the lessee, becomes probable The lessor repossesses the underlying asset and has no further obligation to the lessee under the contract, and the lease payments received from the lessee are nonrefundable The contract is terminated, and the lease payments received from the lessee are nonrefundable Page 31

32 Lessor accounting subsequent measurement (cont.) Operating leases Collectibility is probable Recognizes lease income, generally on a straight-line basis, over the lease term Separately recognizes income for variable lease payments that do not depend on an index or rate when the changes in facts and circumstances on which the variable lease payments are based occur Recognizes changes to variable lease payments that depend on an index or a rate in profit or loss in period of the change Collectibility is not probable Lease income is limited to the lesser of (1) the income that would have been recognized if collection were probable, including income from variable lease payments and (2) the lease payments, including variable lease payments, that have been collected from the lessee If the collectibility assessment changes to probable after the commencement date, any difference between the lease income that would have been recognized if collectibility had always been assessed as probable and the income recognized to date is recognized as a current-period adjustment to lease income If the collectibility assessment changes to not probable after the commencement date, lease income is reversed if the lease payments, including variable lease payments, that have been collected from the lessee are less than the income recognized to date Page 32

33 Lessor accounting presentation Balance sheet Income statement Statement of cash flows Sales-type leases Direct financing leases The net investment in the lease is presented separately from other assets The net investment in the lease is subject to the same considerations as other assets in classification as current or noncurrent assets Operating leases Underlying assets are presented in accordance with other applicable guidance All leases types Income arising from leases is presented separately from other activity or disclosed in notes Sales-type leases Direct financing leases Profit (for sales-type leases) or loss (for sales-type and direct financing leases) recognized at commencement date is presented on either a gross or a net basis, based on lessor s business model All leases types Cash lease payments received are presented within operating activities Page 33

34 Sale and leaseback transactions lessees and lessors Is the transaction a sale under ASC 606 (i.e., does it transfer control of the asset to the buyer-lessor)? No Yes Is the leaseback classified as a sales-type lease by the buyer-lessor or a finance lease by the seller-lessee? Yes No No Does the transaction include a option for the seller-lessee to repurchase the asset? Yes Does the repurchase option meet both of the following conditions? The exercise price of the option is the fair value of the underlying asset at the time the option is exercised Alternative assets that are substantially the same as the transferred asset are readily available in the marketplace Yes No Account for as a sale and leaseback transaction Account for as a financing transaction (i.e., a failed sale and leaseback) Page 34

35 Sale and leaseback transactions lessees and lessors (cont.) Seller-lessee Buyer-lessor Sale and leaseback transaction accounting Accounting for the sale Recognizes the transaction price for the sale in accordance with ASC 606 Derecognizes the carrying amount of the underlying asset Recognizes any gain or loss, adjusted for off-market terms, immediately Accounting for the leaseback Same manner as other operating leases, adjusted for off-market terms Additional disclosure requirements Accounting for the purchase Recognizes the asset in accordance with ASC 360, Property, Plant, and Equipment Accounting for the leaseback Same manner as other direct financing or operating leases, adjusted for offmarket terms Financing transaction accounting (failed sale and leaseback) Recognizes a financial liability Recognizes a loan receivable Page 35

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