Proposed New Accounting Standards For Leases

Transcription

1 Relationships backed by performance. Proposed New Accounting Standards For Leases Doug Richardson Live Seminar 9:00am 10:30am June

2 Overview and Background Leases serve a vital role in many entities operations and contain provisions that range from simple to complex. This guidance establishes principles for lessees and lessors for recognizing, measuring, presenting and disclosing: a: Assets and liabilities arising from lease agreements; b: Disclosure information about leasing arrangements; c: Amounts, timing and uncertainty of the cash flows arising from lease arrangements.

3 Scope This guidance applies to all leases, including leases of right-of-use assets, in a sublease This guidance does not apply to the following: Leases of intangible assets Leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources Leases of biological assets (biological assets include items such as live animals and plants)

4 Rules applicable to the Lessee At the date of commencement of a lease, a lessee shall recognize in the statement of financial position (balance sheet) a right-of-use asset and a liability to make lease payments. This pronouncement requires use of the lessee s incremental borrowing rate in calculating the associated interest related to the lease similar to capitalized interest on fixed assets. Similar to the current capital lease rules, the new calculations will be interest expense on the liability to make lease payments. The old rules go away and every lease except for those identified within the original scope will create an asset and liability regardless of the terms of the agreement.

5 Initial Measurement - Lessee At the date of inception, a lessee shall measure the liability to make lease payments at the present value at either: a. The rate the lessor charges the lessee under the lease agreement, if it can be readily determined, or; b. The discounted amount using the lessee s incremental borrowing rate for loans of similar nature and terms.

6 Initial Measurement (continued) The lessee shall also measure the right-of-use asset at the amount of the liability to make lease payments given the payment amount and the term of the lease, plus any initial direct costs incurred by the lessee. A lessee shall determine the lease term by estimating the probability of occurrence for each possible term. This consideration must take into account the effect of any options to extend or terminate the lease.

7 Initial Measurement (continued) A lessee shall determine the present value of lease payments payable during the lease term determined on the basis of the expected outcome. The expected outcome is the present value of the probability-weighted average of the cash flows for a reasonable number of outcomes. A. If contingent rentals depend on an index or rate, the lessee shall determine the expected lease payments using readily available forward rates or indices. If forward rates or indices are not readily available, the lessee shall use the prevailing rates or indices. B. The lessee should include an estimate of amounts payable to the lessor under residual value guarantees, if any. C. The lessee needs to consider expected payments to the lessor under term option penalties (if present in the probability estimate range).

8 Subsequent Measurement - Lessee The associated liability to make future lease payments is amortized using the interest rate method. (Straight line method is not allowed). If facts or circumstances indicate there is a significant change in the liability since the previous reporting period, a lessee shall reassess the length of the lease term in accordance with the terms set forth during initial measurement.

9 Subsequent Measurement (continued) A lessee shall distinguish changes in contingent rentals and expected payments under term option penalties and residual value guarantees that relate to prior periods differently from those that related to future periods. For example, when lease payments depend on the amount of the lessee s sales, changes related to sales in the current period or prior periods are recognized in net income. Conversley, changes relating to expectations of future sales are recognized as an adjustment to the right-of-use asset.

10 Subsequent Measurement (continued) Amortization of the right-of-use asset is to be performed on a systematic basis from the date of commencement of the lease to the end of the lease term or over the useful life of the underlying asset if shorter. A lessee shall not change the rate used to discount the lease payments except to reflect changes in reference interest rates when contingent rentals are based on those reference interest rates. When contingent rentals are based on reference interest rates, a lessee shall recognize any changes to the liability to make lease payments arising from changes in the discount rate in net income.

11 Presentation - Lessee Liabilities to make lease payments are to be presented separately from other financial liabilities Right-of-use assets are presented as if they were tangible assets within property, plant and equipment separately from assets that the lessee does not lease.

12 Presentation (continued) Presentation of amortization expense and associated interest shall be presented separately from other amortization and interest expense either in the income statement or in the notes. Cash payments for leases are to be classified as financing activities in the statement of cash flows as a separate line item within the category. Short term leases (less than 12 months) is still undecided They will be measured at the undiscounted obligation and right to use asset and amortized in similar fashion or they will be expensed through the income statement over the lease term (page 5 of exposure draft)

13 Key items to consider New requirements for balance sheet and income statement presentation will require significant changes for entities with debt agreements which include any ratio covenants. Rent expense is replaced with interest and amortization expense. This could result in a significant increase in EBITDA. The balance sheet may significantly change if there are a large number of leases. Please recall, you don t simply calculate the payments based on the original lease term, you must also take into consideration the probability of continued renewals in your calculated estimate. This will often result in consideration of the useful life of the asset.

14 Lessor Accounting The Lessor must determine when to apply the performance obligation approach or de-recognition approach at the lease inception. The determination is based on whether the lessor retains exposure to significant risks or benefits associated with the underlying asset either: During the expected term of the lease; or After the expected term of the lease by having the expectation or ability to generate significant returns by releasing or selling the underlying asset.

15 Lessor Accounting (Cont d) If a lessor does retain exposure to significant risks or benefits associated with an underlying asset, the lessor shall apply the performance obligation approach to the lease. If a lessor does not retain exposure to significant risks or benefits associated with an underlying leased asset, the lessor shall apply the de-recognition approach to the lease. A lessor shall not change the lessor accounting approach after the date of inception of the lease.

16 Performance Obligation Approach ( PBO ) Under the PBO approach, a lessor shall recognize in the statement of financial position a right to receive lease payments and a lease liability. The lessor shall not derecognize the underlying asset. The right to receive lease payments is calculated at the sum of the present value of the lease payments using the rate the lessor charges the lessee and any initial direct costs incurred by the lessor. The lease liability is measured at the present value of the lease payments, discounted using the rate the lessor charges the lessee.

17 PBO - Calculation The lease term is estimated using a probability weighted approach using the probability of occurrence for each possible lease term, taking into account the effect of any options to extend or terminate the lease. This will often result in much longer lease terms than that of the original lease term. The lessor shall discount all of the lease payments to be received including an estimate of contingent rentals receivable. The exercise price or a purchase option included in a lease is not a lease payment and the purchase option is not included in determining the present value of the lease payments. The lease payments shall include an estimate of amounts receivable from the lessee under residual value guarantees that the lessor can reliably measure. The lease payments shall include an estimate of expected payments from the lessee under term option penalties.

18 PBO Subsequent Measurement The right to receive lease payments is amortized using the interest method. The remaining lease liability is determined on the basis of the pattern of use of the underlying asset by the lessee. If the lessor cannot readily determine the remaining lease liability it shall use the straight-line method.

19 PBO Subsequent Measurement The lessor shall reassess the carrying amount of the right to receive lease payments arising from each lease if facts and circumstances indicate there would be a significant change in the right to receive lease payments since the previous reporting period.

20 PBO Subsequent Measurement The reassessment should include: Probable changes in the lease term as an adjustment to the lease liability to reflect any change in the right to receive lease payments from changes to the lease term. It should also include reassessment of the expected amount of any contingent rentals and expected payments under residual value guarantees that the lessor can reliably measure; All changes in the right to receive lease payments shall be recognized in net income to the extent that the lessor has satisfied the related liability or; As an adjustment to the lease liability to the extent that the lessor has not satisfied the related lease liability; however, the lessor shall recognize any changes that would reduce that liability below zero in net income

21 PBO Presentation The lessor (or intermediate lessor in the case of a sub-lease) shall present the following in their statement of financial position: Underlying assets Rights to receive lease payment asset Lease liabilities The total of underlying assets minus the lease liability as a net lease asset or a net lease liability

22 PBO Presentation The lessor shall present lease income resulting from the satisfaction of a lease liability and depreciation expense on an underlying asset separately, totaling to a net lease income or net lease expense in the income statement. The lessor shall classify the cash receipts from lease payments as operating activities in the statement of cash flows. If the lessor: Applies the direct method, it shall present those cash receipts separately from other cash flows from operating activities Applies the indirect method, it shall present changes in the right to receive lease payments separately from the changes in other operating receivables.

23 Derecognition Approach Under the De-Recognition approach, the lessor shall do the following at the commencement of the lease: recognize on the balance sheet the net present value of the right to receive lease payments at the commencement of the lease De-recognize on the balance sheet the portion of the of the carrying amount of the underlying asset that represents the rights that have been transferred to the lessee Reclassify the remaining portion of the asset on the balance sheet as a residual asset.

24 Present Value of Lease Payments The lease term is estimated using a probability weighted approach using the probability of occurrence for each possible lease term, taking into account the effect of any options to extend or terminate the lease. The lessor shall discount all of the lease payments to be received including an estimate of contingent rentals receivable if it can be reliably measure using readily available forward rates or indices. The exercise price or a purchase option included in a lease is not a lease payment and the purchase option is not included in determining the present value of the lease payments. The lease payments shall include an estimate of amounts receivable from the lessee under residual value guarantees that the lessor can reliably measure. The lease payments shall include an estimate of expected payments from the lessee under term option penalties.

25 Derecognition Subsequent Measurement The right to receive lease payments is amortized using the interest method. The lessor shall not re-measure the residual asset unless: The length of the lease term is materially altered during the time between measurement evaluation periods. The expected amount of any contingent rentals and any expected payments under residual value guarantees that the lessor can reliably measure materially change between the measurement evaluation periods.

26 Derecognition Subsequent Measurement The lessor shall apply ASC 310 (impairment guidance) at each reporting date to determine whether the right to receive lease payments is impaired and shall recognize any impairment loss in net income.

27 Contracts that contain both service components and lease components An entity shall apply the proposals in the boards exposure draft on revenue from contracts with customers to identify separate performance obligations within a contract that contains both service components and lease components. If the service component is not distinct, a lessee and a lessor shall account for the whole of the contract as a lease. It is important to clearly delineate service and lease components to prevent lease treatment of period production expenses.

28 Disclosure An entity shall disclose qualitative and quantitative financial information that: Identifies and explains the amounts recognized in the financial statements arising from leases. Describes how leases may affect the amount, timing and uncertainty of the entity s future cash flows. An entity shall aggregate or disaggregate disclosures so that useful information is not obscured by either the inclusion of a large amount of insignificant detail or the aggregation of items that have different characteristics.

29 Disclosure An entity shall disclose the nature of its lease arrangements, including: A general description of those lease arrangements The basis and terms on which contingent rentals are determined The existence and terms of options, including for renewal and terminations. A lessee shall provide narrative disclosure about the options that were recognized as part of the right-of-use asset and those that were not The existence and principal terms of any options for the lessee to purchase the underlying asset Information about the assumptions and judgments relating to amortization methods and changes to those assumptions and judgments. The existence and terms of residual value guarantees Initial direct costs incurred during the reporting period Restrictions imposed by lease arrangements Information about the principal terms of any lease that has not yet commenced if the lease creates significant rights and obligations for the entity The nature and amount of significant subleases

30 Disclosure An entity shall disclose the nature of its lease arrangements, including: If the entity accounts for short-term leases using the shortcut method that fact, and for lessees, the amount recognized in the statement of financial position for such short-term leases A lessee shall disclose a reconciliation of opening and closing balances of right-of-use assets and liabilities to make lease payments, disaggregated by class of underlying asset. The reconciliation shall separately show the total cash lease payments paid during the period. A lessor shall disclose the information about its exposure to the risks or benefits associated with the underlying asset that is used in determining whether to apply the performance obligation approach or derecognition approach A lessor shall disclose impairment losses arising from leases to which it applies the performance obligation approach separately from those to which it applies the derecognition approach A lessor shall disclose information about the nature and amount of each class of residual asset arising from leases to which it applies the derecognition approach

31 Disclosure An entity shall disclose the nature of its lease arrangements, including: A lessor shall disclose a reconciliation of the opening and closing balances for each of the following: Rights to receive lease payments Lease liabilities arising from leases to which it applies the performance obligation approach Residual assets arising from leases to which it applies the derecognition approach A lessor shall disclose information about the nature of significant service obligations related to its leases. Information about significant assumptions and judgments and any changes in assumptions and judgments relating to renewal options, contingent rentals, term option penalties, residual value guarantees and the discount rate used when determining the present value of lease payments A maturity analysis of the liabilities to make lease payments showing the undiscounted cash flows on an annual basis for the first five years and a total of the amounts for the remaining years. The maturity analysis shall distinguish the minimum obligations specified in the lease and the amounts recognized in the statement of financial position

32 Transition and Effective Date Although the period for comment has ended on the original proposed amendment, due to the level and nature of the comments an updated version of the exposure draft is anticipated to be released again in While there is not a general consensus in the accounting community most believe the earliest this could be implemented would be 2015 but more likely 2016 if it is eventually finalized. There were 786 comment letters sent to FASB regarding the standard. By and large these comment letters were highly critical of FASB and their standard setting process in this area.