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KPMG s CFO Financial Forum Webcast FASB/IASB Revised Lease Accounting Exposure Drafts A Detailed Look Part III: Lessor Accounting June 25, 2013 Administrative CPE regulations require online participants to take part in online questions You must respond to a minimum of 7 questions in order to be eligible for CPE credit Polling questions will appear on your media player on top of the slides Send Questions via Ask a Question Button Help Desk: 1-877-398-1471 or outside the U.S. at +1-954-969-3342 You can print out presentation slides from the Supporting Material icon CPE questions should be directed to us-mktcpedistribute@kpmg.com Reference materials are available Slides Defining Issues Issues In-Depth member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 2 1

Agenda Overview The Receivable & Residual Model The Operating Lease Model Presentation and Disclosure Transition Question & Answer Session member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 3 Polling Question #1 Please select the choice below that best describes you? A. I am an accounting professional with a company that is a financial statement preparer B. I am a user of financial statements that will be impacted by the lease accounting standard C. I am an accountant at a public accounting firm or other professional accounting body D. I am an accounting professor E. I am an otherwise interested party member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 4 2

Overview Leases for Lessors May 16, 2013: ED published and comment period begins September 13, 2013: Comment period ends Proposed date of transition Proposed date of adoption Earliest annual financial statements in which proposals would apply Overview Dual lease model: partial sale (Type A) or operating lease-like (Type B) accounting Lease classification tests same as those that apply to lessees More complex accounting requirements Simplified requirements for some short term leases 12 months More disclosure of leasing arrangements How to apply the standard Type A Receivable and Residual (R&R) model similar to partial sale accounting; at lease commencement derecognize underlying asset and recognize: a lease receivable (PV of estimated future lease payments) a residual asset upfront profit or loss in some cases interest income on lease receivable and income on accretion of residual asset over the lease term Type B operating lease model similar to current operating lease accounting member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 6 3

Polling Question #2 Which best describes your organization s role as a lessor: A. We principally lease real estate B. We principally lease equipment C. We provide leases of both real estate and equipment D. We generally are the lessor only in sublease transactions E. We invest in, or provide financing to, lessors member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 7 Overview of Proposed Accounting Models Lessor Right to use leased property Lessor Models Lessee Right-of-Use (ROU) Model Type A leases: Receivable and Residual model (most non-property 1 leases) Lease payments Recognize right to receive estimated future lease payments Recognize residual asset Type B leases: Operating Lease model (most property 1 leases) Recognize leased property Do not recognize right to receive estimated future lease payments 1 Property = land and/or buildings (or part of a building) member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 8 4

Lessor Accounting Models Underlying Principles R&R model (Type A leases): A lease is the sale of a more than insignificant portion of the underlying asset (usually financed by the lessor) The underlying asset is exchanged for a financing receivable due from the lessee and a residual interest in the underlying asset both accreted at the rate the lessor charges the lessee Operating Lease model (Type B leases): A lease represents the service of providing access to an underlying asset for a period of time Underlying asset remains on the lessor s books as it is used by the lessor to provide the service to the lessee Lessor Investment Comparison Lease Net Income Comparison $80,000 $70,000 $60,000 $50,000 $40,000 $30,000 $20,000 $10,000 $0 Lease Term Unearned Profit Lessor Investment: Sales Type Lease Current U.S. GAAP Lessor Investment: R&R Model (Net of Deferred Profit) Lessor Investment: Operating Lease Current U.S. GAAP $35,000 $30,000 $25,000 $20,000000 $15,000 $10,000 $5,000 $0 Lease Term Sales Type Lease Net Income Current U.S. GAAP R&R Model Net Income Operating Lease Net Income Current U.S. GAAP member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 9 Polling Question #3 Type A Leases would be accounted for by the lessor utilizing which of the following? A. Operating Lease Model B. Performance Obligation Model C. Receivable and Residual Model D. Derecognition Model member 10 5

Polling Question #3 Answer The correct answer is C. Under the Boards revised exposure drafts, lessors will account for Type A leases utilizing the receivable and residual model. Lessors will account for Type B leases using the operating lease model (choice A). Choices B and D are the two approaches/models proposed for lessors in the Boards 2010 exposure drafts. member 11 The Receivable and Residual Model 6

Receivable and Residual Model (Type A Leases) Lease Receivable Lease receivable Lease term PV of estimated future lease payments includes expectations about Termination penalties Purchase options Variable lease payments Payments structured as RVGs Discount rate = rate the lessor charges the lessee (takes into account the nature of the transaction as well as the terms of the lease, for example, the rate implicit in the lease, or the property yield) The proposed standard does not specify when (or if) a lessor would be required to include estimated variable lease payments in its calculation of the discount rate when the rate the lessor charges the lessee is best reflected by the rate implicit in the lease. member 13 Example #1 Determining the Lessor Discount Rate Example: Lessor enters into a lease of a machine with Lessee. The lease term is five years, for which Lessee will pay Lessor annual rent (in arrears) equal to $20 for every machine hour of operation in addition to a base rental of $1,000 per year. Lessor s estimated residual value of the machine at the end of the lease term contemplates that the machine will be operated a minimum of 2,000 hours per year. Using a payment stream comprised of Lessor s estimated residual value of the machine together with the base rental of $1,000 per year would result in an implicit interest rate that is below the risk-free interest rate. Should Lessor include estimated variable lease payments in its determination of the appropriate discount rate (and therefore, in its net residual asset as well)? member 14 7

Example #1 Determining the Lessor Discount Rate (continued) Solution: In this scenario, Lessor would likely conclude that it should include the estimated variable lease payments in its determination of the discount rate. The rate implicit in the lease is the discount rate that when applied to the future lease payments and the gross residual value results in those amounts equaling the fair value of the underlying asset at lease commencement. In this lease, if Lessor does not include the estimated variable lease payments in its determination of the discount rate, the resulting rate will be inconsistent with factors such as market interest rates, Lessee s credit profile, etc. member 15 Example #2: Determining the Lessor Discount Rate Example: Lessee enters into a six-year lease of a vehicle from Lessor, for which Lessee will pay Lessor annual fixed rent (in arrears) of $15,000/year. Lessee will also pay Lessor incremental usage charges for using the vehicle more than a specified amount. Lessor s estimated residual value at the end of the lease term used in pricing the lease assumes that Lessee will not use the vehicle more than the specified amount. The incremental usage charges are designed to compensate Lessor for the decline in residual value that would result from any excess usage of the vehicle. Should Lessor include estimated variable lease payments (i.e., those amounts that are not in-substance fixed payments) in its determination of the appropriate discount rate (and therefore, in its net residual asset as well)? member 16 8

Example #2 Determining the Lessor Discount Rate (continued) Solution: In this scenario, Lessor would not need to include the estimated variable lease payments in its discount rate. In this lease, Lessor s discount rate is unlikely to be significantly affected by whether or not it includes an estimate of variable lease payments in its determination of the discount rate because the incremental usage charges are designed to compensate it for the decline in residual value that would result from any excess usage of the vehicle. As a result, Lessor may appropriately determine the discount rate either with or without an estimate of variable lease payments. member 17 Example #3: Lease Payment Structured as a Residual Value Guarantee Example: Lessor leases a machine with a total economic life of 8 years to Lessee for 4 years for annual payments of $10,000, paid in arrears. The lease contract guarantees a residual value of $30,000 at the end of the 4-year lease, while also stipulating that if the machine is sold for more than $30,000 after the lease term, Lessor will pay Lessee any surplus. Would Lessor include any amounts attributable to the contract s residual value guarantee in its lease receivable? Solution: In this example, $30,000 would be considered a fixed lease payment structured as a residual value guarantee; therefore, Lessor would include that $30,000 in its initial lease receivable. member 18 9

Polling Question #4 Following on from the previous example, if the lease contract did not require Lessor to pay Lessee any surplus amount earned from resale of the machine above the guaranteed residual amount, but Lessor expected that Lessee would be required to make a payment under the residual value guarantee clause in the contract, would Lessor include that expected payment in its initial lease receivable? A. Yes B. No member 19 Polling Question #4 Answer The correct answer is no. Lessor would exclude the guarantee from lease payments even if it expected to receive a payment from Lessee under the guarantee at lease commencement. Lessees will include any such expected payments in their initial lease liability; however, lessors will not. member 20 10

Receivable and Residual Model (Type A Leases) Residual Asset Lease receivable PV of estimated future lease payments Plus (+) Initial direct costs Net residual asset Gross residual asset Plus (+) PV of estimated VLPs Less (-) Unearned profit Gross residual asset = PV of estimated future residual value discounted at lessor discount rate Unearned profit = (FV of leased asset carrying amount of leased asset) (1 [PV of lease payments FV of leased asset]) member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 21 Receivable and Residual Model (Type A Leases) Initial Profit or Loss Profit / Loss Upfront profit/loss: (Fair value carrying amount of leased asset) PV of lease payments FV of leased asset Unearned profit/loss 1 : (Fair value carrying amount of leased asset) [1 (PV of lease payments FV of leased asset)] 1 All or a portion of unearned profit / loss recognized upon (a) a sale or re-lease of the underlying asset, (b) a reassessment that affects the measurement of the residual asset, (c) an impairment of the residual asset, or (d) a lease modification member 22 11

Lease Receivable Subsequent Measurement and Reassessments Amortized cost using the effective interest method; no fair value option Changes in carrying amount of lease receivable due to: Reassessment of lease term and purchase options Reassessment of VLPs based on an index or rate Adjust residual asset Recognize in P&L Discount rate is reassessed unless change in lease receivable relates solely to VLPs based on a non-interest-rate index. member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 23 Receivable and Residual Model Subsequent Measurement of Residual Asset Residual asset unearned profit with accretion of gross amount (effective interest method) Accretion reported as interest income in the P&L (increases the residual asset each period) Gross Residual Asset Balance Discount Rate Portion of residual asset attributable to variable lease payments that impacted the rate the lessor charges the lessee (if applicable) derecognized (i.e., decreases the carrying amount of the residual asset) over the lease term. Original Estimate of VLPs for the period Original estimate of VLPs for lease term PV of original estimate of VLPs for the lease term Carrying amount of underlying asset at lease commencement FV of underlying asset at lease commencement Residual assets are subject to existing impairment testing requirements for PP&E (RVGs considered in evaluation) member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 24 12

Polling Question #5 Which of the following factors would not lead to a change in the carrying amount of the lessor s lease receivable? A. A change in the lessor s s estimate of payments it will receive under a residual value guarantee B. A change in the lease term resulting from a change in the lessor s assessment as to whether the lessee has a significant economic incentive to exercise a renewal or termination option. C. A change in the lessor s assessment of whether the lessee has a significant economic incentive to exercise a purchase option for the underlying asset D. A change in the index or rate used in estimating variable lease payments based on an index or rate member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 25 Polling Question #5 Answer The correct answer is A. Choices B-D would all result in an adjustment to the carrying amount of the lessor s lease receivable e as of the reassessment e date. Choice A is the correct answer because a lessee s s estimated payments under residual value guarantees are not included in the lessor s lease receivable (such payments are included in the lessee s lease liability). member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 26 13

Example #4 Lessor Receivable and Residual Model (Type A Lease) Fact pattern for example: Lease term 5 years Total economic life of leased asset (equipment) 15 years Estimated future residual value at end of year 5 $ 75,000 Present value of estimated future residual $ 44,719 Fair value of leased asset $230,000 Carrying amount of leased asset $200,000 Rate lessor charges lessee 10.896% Annual payments in arrears $ 50,000 Present value of lease payments $185,281 member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 27 Example #4 Lessor Receivable and Residual Model (continued) Net residual asset components: Fact pattern Estimated future residual $ 75,000 Gross residual asset: $44,719 value Unearned profit: (5,833) Present value of estimated $ 44,719 Calculation of net residual asset: future residual Gross residual asset: $44,719 Fair value of leased asset $230,000 Unearned profit: (5,833) Carrying amount of leased $200,000 asset Net residual asset: $38,886 Present value of lease $185,281 Calculation of unearned profit: payments Total profit less profit recognized at lease commencement (i.e., day 1 profit) = (fair value carrying amount of the leased asset) [1 (present value of lease payments fair value of the leased asset)] ($230,000 $200,000) [1 ($185,281 $230,000)] = $5,833 member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 28 14

Example #4 Lessor Receivable and Residual Model (continued) Statement of financial position Profit or loss Gross Gross Lease residual Unearned Net residual Day 1 Interest residual Net Period receivable asset profit asset profit income accretion income 0 $185,281 $44,719 $(5,833) $38,886 886 $24,167 $ - $ - $ 24,167 1 155,468 49,591 (5,833) 43,758-20,187 4,872 25,059 2 122,408 54,994 (5,833) 49,161-16,940 5,403 22,343 3 85,745 60,986 (5,833) 55,153-13,337 5,992 19,329 4 45,087 67,631 (5,833) 61,798-9,342 6,645 15,987 5-75,000 (5,833) 69,167-4,913 7,369 12,282 Totals $24,167 $64,719 $30,281 $119,167 Gross residual accretion year 1: $44,719 10.896% = $4,872 Unearned profit not recognized until asset is sold or re-leased Day 1 profit: (Fair value carrying amount of the leased asset) present value of lease payments fair value of the leased asset ($230,000 $200,000) $185,281 $230,000 = $24,167 member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 29 Example #4 Lessor Receivable and Residual Model (continued) Statement of financial position Profit or loss Gross Gross Lease residual Unearned Net residual Day 1 Interest residual Net Period receivable asset profit asset profit income accretion income 0 $185,281 $44,719 $(5,833) $38,886 886 $24,167 $ - $ - $ 24,167 1 155,468 49,591 (5,833) 43,758-20,187 4,872 25,059 2 122,408 54,994 (5,833) 49,161-16,940 5,403 22,343 3 85,745 60,986 (5,833) 55,153-13,337 5,992 19,329 4 45,087 67,631 (5,833) 61,798-9,342 6,645 15,987 5-75,000 (5,833) 69,167-4,913 7,369 12,282 Totals $24,167 $64,719 $30,281 $119,167 Net income ASC 840 operating lease: $ 250,000 Total lease payments (125,000) Total depreciation exp. $ 125,000 Total income Net income per year = $25,000 Net income R&R model: $119,167 Net income 5,833 Unearned profit $125,000 Total income Accelerated income recognition member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 30 15

Example #4a Lessor Receivable and Residual Model (Impairment of Lease Receivable) Scenario: At the end of Year 4 Lessee defaults on the lease because it does not make the required lease payment. Lessor measures the allowance for expected losses on the lease receivable using applicable financial instruments guidance. Lessor has the right to repossess the machine in the event of a Lessee default Lessor expects that it could sell the machine for $100,000 at the end of Year 4 Lessor estimates that the residual value of the machine at the end of the lease term is still $75,000 Evaluation: In measuring the impairment allowance, Lessor does the following: Step 1: Calculate the difference between the cash flows that would result from sale of the machine if repossessed (i.e., $100,000) 000) and the carrying amount of the gross residual asset of $67,631 at the same date (i.e., at the end of Year 4), which equals $32,369 Step 2: Allocate the amount determined in Step 1 ($32,369) to the lease receivable and record the difference between that amount and the carrying amount of the lease receivable immediately before the impairment ($45,087) as bad debt expense ($12,718) with a corresponding reduction to the lease receivable member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 31 Example #4a Lessor Receivable and Residual Model (Impairment of Lease Receivable) - continued Evaluation (continued from previous slide): Assume Lessee does not remediate the default and Lessor repossesses the machine. Lessor records the machine as PP&E (or inventory, depending on the circumstances) at the sum of the remaining lease receivable ($45,087 - $12,718 = $32,369) plus the net residual asset at the end of Year 4 ($61,798), which effectively equals the estimated price for which Lessor could sell the machine ($100,000) less the existing unearned profit ($5,833): Debit Credit PP&E (or Inventory) 94,167 Unearned Profit 5,833 Lease Receivable 32,369 Gross Residual Asset 67,631 Upon sale of the machine to a third-party t for $98,000 (i.e., less than the estimated t amount), Lessor records a gain as follows: Debit Credit Cash 98,000 PP&E (or Inventory) 94,167 Gain 3,833 member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 32 16

Polling Question #6 What guidance will a lessor reference in evaluating whether its lease receivable is impaired? A. Impairment guidance for long-lived lived assets (e.g., ASC 360 or IAS 36) B. Impairment guidance for goodwill and indefinite-lived intangible assets (e.g., ASC 350 or IAS 36). C. Impairment guidance for financial instruments (e.g., ASC 310 or IFRS 9) D. N/A The lessor s lease receivable will not be assessed for impairment once it is initially recorded. member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 33 Polling Question #6 Answer The correct answer is C. Lessors will evaluate their lease receivables for impairment in accordance with the applicable financial a instruments ts impairment guidance. Choice A is incorrect because a lessor s s residual asset will be assessed for impairment in accordance with the applicable long-lived assets impairment guidance. Choice B is incorrect because goodwill and indefinite-lived intangible asset impairment guidance is not applied by a lessor in evaluating its lease assets (i.e., either its lease receivable or residual asset) for impairment, while Choice D is incorrect because a lessor s lease receivable is subject to impairment testing. member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 34 17

Example #5 Lessor Receivable and Residual Model (Type A Lease) that Includes Variable Lease Payments Fact pattern for example: Lease term 5 years Total economic life of leased asset (equipment) 15 years Estimated future residual value at end of year 5 $ 30,000 Present value of estimated future residual $ 19,998 Fair value of leased asset $ 57,000 Carrying amount of leased asset $ 50,000 Rate lessor charges lessee (rate implicit in the lease) 8.45% 1 Fixed annual payments in arrears $ 25,000 Present value of fixed lease payments $ 19,729 Net present value of expected VLPs based on excess usage $ 17,273 (undiscounted amount = $20,500: $5,000 in Year 1; $10,000 in Year 2; $3,000 in Year 3; $2,500 in Year 4; $0 in Year 5) 1 Discount rate required for the present value of fixed lease payments + NPV of estimated VLPs + PV of gross residual asset = FV of underlying asset member 35 Example #5 Lessor Receivable and Residual Model (Type A Lease) that Includes Variable Lease Payments (continued) The lessor would calculate the residual asset as illustrated below and would accrete it to the end of the lease term using the rate the lessor charges the lessee. Income Statement Balance Sheet Cost Present Value Future CF Mfg Profit Interest/ Accretion Total Profit Beg. Ending Receivable $17,306 $19,729 $25,000 $2,423 $ 5,271 $ 7,694 $19,729 $ - Gross residual 17,542 19,998 30,000-10,002 10,002 19,998 30,000 Estimated variable payments 15,152 17,273 20,500 5,348-5,348 17,273 2,121 Unearned profit - - - - - - (4,577) (4,577) Total $50,000 $57,000 $75,500 $7,771 $15,273 $23,044 $52,423 $27,544 At lease commencement the lessor would recognize a receivable of $19,729 for the present value of the estimated lease payments and a net residual asset of $32,694, calculated as [PV of estimated future residual value at end of lease term + PV of estimated variable lease payments included in determining lessor discount rate but excluded from PV of lease payments unearned profit] = [$19,998 + $17,273 $7,000 (total profit) + $2,423 (profit recognized at lease commencement)], and derecognize the underlying asset Profit of $2,423, calculated as [(fair value of underlying asset carrying amount of underlying asset) present value of estimated lease payments fair value of underlying asset] = [($57,000 $50,000) 19,729 $57,000], would be recognized at lease commencement Profit of $4,577, calculated as [fair value of underlying asset carrying amount of underlying asset profit recognized at lease commencement] = [$57,000 $50,000 2,423], would be deferred The residual asset (including the present value of estimated variable lease payments) would be presented net of the unearned profit amount (i.e., $32,694 = [$19,998 + $17,273 $4,577]) in the statement of financial position member 36 18

Example #5 Lessor Receivable and Residual Model (Type A Lease) that Includes Variable Lease Payments (continued) The table below summarizes profit under the R&R model as compared to operating lease accounting under current GAAP. Receivable and Residual Model Current Operating Lease Accounting Lease Gross Residual Unearned Net Residual Return on Underlying Return on Year Receivable Asset (a) Profit (b) Asset Profit (b) Assets Asset Profit Assets 0 $19,729 $37,271 $4,577 $32,694 $2,423 $50,000 1 16,396 35,265 4,577 30,688 4,661 8.9% 46,000 $6,000 12.0% 2 12,781 29,706 4,577 25,129 5,826 12.4% 42,000 11,000 23.9% 3 8,861 29,477 4,577 24,900 3,851 10.2% 38,000 4,000 9.5% 4 4,610 29,784 4,577 25,207 3,556 10.5% 34,000 3,500 9.2% 5-32,121 4,577 27,544 2,727 9.1% 30,000 1,000 2.9% $23,044 $25,500 (a) The sum of: (1) end of period PV of the underlying asset s estimated end of lease term FV ($30,000) discounted using the rate the lessor charges the lessee plus (2) lease commencement date PV of estimated variable lease payments included in determining the lessor s discount rate but excluded from the lease receivable minus (3) cumulative periodic reduction to lease income for the cost of estimated variable lease payments. The excess of the gross residual asset over the underlying asset s estimated end of lease term FV ($32,121 - $30,000) represents the portion of unearned profit related to estimated variable lease payments (i.e., total profit lease commencement PV of estimated variable lease payments lease commencement fair value of underlying asset). Adding this amount to the gross residual asset results in recognition (i.e., non-deferral) of that profit over the lease term (hence, the difference between operating lease accounting profit of $25,500 and $23,044 = $2,456 [$4,577 - $2,121]). (b) Periodic profit would include accretion of the residual asset plus interest on the lease receivable plus actual variable lease payments less the periodic cost of estimated variable lease payments, calculated as [estimated variable lease payments for the period total estimated variable lease payments present value of total estimated variable lease payments carrying amount of underlying asset fair value of underlying asset]. If the underlying asset were sold at the end of Year 5 for the estimated residual value of $30,000, profit in Year 5 would be $5,183 ($2,727 + $30,000 - $27,544) and total profit would be $25,500 ($23,044 - $2,727 + $5,183). member 37 The Operating Lease Model 19

Operating Lease Model (Type B Leases) Financial Position Profit or Loss Lessor does not recognize a financial asset Underlying asset remains on lessor's balance sheet Lease income is recognized generally on a straight-line basis No interest income recognition Lessor total lease income may differ from lessee total lease expense under straight-line ROU model if differing assumptions about lease term, purchase options, etc. Lessor's recognized underlying asset (not a financial asset) lessee s recognised financial liability member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 39 Example #6 Lessor Operating Lease Model (Type B Lease) Fact pattern for example: Lease term 10 years Remaining economic life of leased asset (building) 30 years Fair value of leased asset $20,000,000 Carrying amount of leased asset $15,000,000 Estimated useful life of leased asset (building) 30 years Annual payments in arrears $1,000,000 This building lease is a Type B lease because the underlying asset is property and the lease term of 10 years is not a major part of the remaining economic life of the underlying asset, nor is the present value of the lease payments ($10,000,000 in total on an undiscounted basis) substantially all of the fair value of the building. member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 40 20

Example #6 Lessor Operating Lease Model (Type B Lease) (continued) Lessor will not derecognize the building and will continue to depreciate the asset over its estimated useful life (30 years) Lease income will be recognized on a straight-line basis over the 10-year lease term No other assets or liabilities will be recorded Operating Lease Model Balance Sheet Income Statement (in 000s) (in 000s) Year PP&E Lease Income Depreciation Expense Profit 0 $ 15,000 $ - $ - $ - 1 14,500 1,000 500 500 2 14,000 1,000 500 500 3 13,500 1,000 500 500 4 13,000 1,000 500 500 5 12,500 1,000 500 500 6 12,000 1,000 500 500 7 11,500 1,000 500 500 8 11,000 1,000 500 500 9 10,500 1,000 500 500 10 10,000 1,000 500 500 $ 10,000 $5,000 $5,000 member 41 Polling Question #7 Which of the following is true with respect to the operating lease model lessors will apply to Type B leases? A. Lessors will not derecognize the underlying asset and will continue to depreciate that asset B. Lessors will derecognize the underlying asset and record a lease receivable and residual asset in its place C. Lessors will record a lease receivable and a performance obligation liability reflecting their right to receive lease payments and an obligation to provide access to the underlying asset to the lessee, while not derecognizing the underlying asset D. Lessors will recognize an upfront profit or loss for the difference between the fair value of the underlying asset at lease commencement and its carrying amount member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 42 21

Polling Question #7 Answer The correct answer is A. Under the lessor operating lease model, the underlying asset will remain on the lessor s books and continue to be depreciated in the same manner as other owned PP&E. Choice B is incorrect because that is what occurs when applying the lessor receivable and residual model. Choice C is incorrect because it reflects the performance obligation approach proposed by the Boards in their 2010 exposure drafts, which was not carried forward to their revised exposure drafts. Choice D is incorrect because a lessor would not recognize any upfront profit or loss under the operating lease model. member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 43 Presentation and Disclosure 22

Lessor Presentation Statement of Financial Position Statement of Comprehensive Income Statement of Cash Flows R&R Model (Type A Leases) present lease receivables and residual assets (including unearned profit) as, or totaling to, a single caption (e.g., lease assets), or disclose separately in the notes if not separately presented Operating Lease Model (Type B Leases) no lease receivable or residual asset presented; underlying leased asset remains lessor PP&E Present lease income and expense Classify all cash inflows from separately or disclose in the notes if not leases as operating activities separately presented separately from other R&R Model (Type A Leases) accretion operating cash flows (direct of the residual asset and amortization of method), or present changes initial direct costs included in interest in lease receivables (R&R income model) separately from changes in other operating If the lessor uses lease arrangements receivables (indirect method) for the purpose of financing, then present commencement date net lease income and expense in a single line item If the lessor uses leases as an alternative to selling (e.g., many manufacturers and dealers), then present commencement date lease income and expense as separate line items member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 45 Disclosures Lessor Disclose quantitative and qualitative financial information that enables financial statement users to evaluate amount, timing and uncertainty of cash flows arising from lease contracts, including: Nature of, and restrictions imposed by, lease arrangements (same as for lessee) Information about significant judgments and assumptions made in applying the standard and changes to those judgments and assumptions (same as for lessee) Information about the nature of significant service obligations related to leases Nature and amount of significant subleases Tabular disclosure of all lease-related income items recognized during the reporting period (interim as well as annual periods for lessors applying U.S. GAAP only) disaggregated into: For leases accounted for under the R&R model: Profit recognized at lease commencement (split into revenue and cost of sales if applicable) Interest income on lease receivables Interest income on residual assets For leases accounted for as operating leases (including short-term leases), income from noncontingent lease payments Income from variable lease payments In interim financial statements of lessors applying IFRS, disclose income from leases Lessors could omit the details about income that would be required in the annual tabular disclosure of lease income unless that information would be significant to the interim financial statements member 46 23

Lessor Reconciliation of Lease Income Example Example Lessor reconciliation of lease income Lease income Type A leases Profit at lease commencement XXX Interest income on lease receivables XX Interest income from accretion of residual assets XX Subtotal XXXX Lease income Type B leases XXX Lease income from short-term leases X Lease income from variable lease payments X Total lease income XXXX member 47 Disclosures Lessor (continued) Disclose quantitative and qualitative financial information that enables financial statement users to evaluate amount, timing and uncertainty of cash flows arising from lease contracts, including: For leases accounted for under the R&R model: Reconciliation between opening and closing balances for lease receivables and residual assets Contractual t maturity analysis of gross undiscounted dreceivable for estimated t dfuture lease payments on annual basis for first five years, lump sum for remainder, reconciled to lease receivable recognized Information about exposure to the underlying asset and how that exposure is managed, including guaranteed vs. unguaranteed residual carrying amounts IFRS preparers IFRS 7 disclosures relating to risks surrounding the lease receivable U.S. GAAP preparers disclosures related to credit quality For leases accounted for under the operating lease model: Contractual maturity analysis (separate from the R&R model lease receivable maturity analysis) of gross undiscounted estimated future lease payments on annual basis for first five years, with lump sum for remainder The cost and carrying amount of property on lease or held for lease by major classes of property according to its nature or function, and the amount of accumulated depreciation in total t as of the date of the latest t balance sheet presented Disclosure if alternative approach for short-term leases used Provide applicable disclosures for transferred lease receivables (ASC Topic 860 or IFRS 7) member 48 24

Polling Question #8 Which of the following is true with respect to lessor financial statement presentation? A. Lessors will classify all cash flows related to leasing activities as cash flows from investing activities B. The lessor s performance obligation liability will be presented separately from a lessor s other liabilities C. Residual assets resulting from operating leases must be presented separately from associated lease receivables. D. Lessors will present changes in lease receivables under the R&R model in the statement of cash flows separately from changes in other operating receivables if applying the indirect method member 49 Polling Question #8 Answer The correct answer is D. Lessors will present changes in lease receivables under the R&R model in the statement of cash flows separately from changes in other operating receivables if applying ppy the indirect method. Choice A is incorrect because a lessor s cash flows resulting from lease activities will not be classified as investing activities in the statement of cash flows. Choice B is incorrect because in no circumstance will lessors record performance obligation liabilities under the Boards revised proposals. Choice C is incorrect because lessors applying the operating lease model will not record residual assets or lease receivables. member 50 25

Transition Lessor Transition Option for full retrospective application (can be applied to all or to select leases by classification) Option to quasi-grandfather current sales-type and direct financing leases Apply subsequent measurement guidance in proposals, except for reassessment requirements, to lease receivable Do not apply the subsequent measurement provisions in the proposals to the residual asset Classify net investment in these leases as lease receivables from Type A leases For current operating leases to be accounted for under the R&R model, option to apply modified retrospective transition with specified transition reliefs Entity-level optional transition reliefs (with disclosure): Not to evaluate initial direct costs for leases that began before the effective date Use of hindsight when preparing comparative financial information Under modified retrospective transition at date of initial application (i.e., beginning of earliest comparative period presented), recognize and measure a receivable for estimated lease payments discounted at the rate lessor charges lessee, and a residual asset Rate lessor charges lessee determined as of lease commencement date Residual asset determined as required by the R&R model using information as of the date of initial application Prepaid or accrued lease payments would adjust the cost basis of the underlying asset that is derecognized at the date of initial application Continue to account for securitized operating lease receivables as secured borrowings using current U.S. GAAP or IFRS as applicable regardless of whether lessor elects full retrospective application Cumulative-effect adjustment in opening retained earnings of earliest comparative period presented Apply the proposed leases guidance to existing leveraged leases retrospectively (FASB Only) member 52 26

Question & Answer Session Presenters contact details Kimber K. Bascom 212-909-5664 kbascom@kpmg.com Scott A Muir 212-909-5073 smuir@kpmg.com member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 54 27

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