The Dbriefs Financial Reporting series presents: FAQs about the new FASB leases standard: You're not alone

The Dbriefs Financial Reporting series presents: FAQs about the new FASB leases standard: You're not alone May 8, 2017 Bob Uhl, Partner, Deloitte & Touche LLP James Barker, Partner, Deloitte & Touche LLP Kristin Bauer, Partner, Deloitte & Touche LLP Sean Torr, Managing Director, Deloitte & Touche LLP Taylor Paul, Manager, Deloitte & Touche LLP

Keep in mind This webcast does not provide official Deloitte & Touche LLP interpretive accounting guidance. Check with a qualified advisor before taking any action. Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 2

Agenda Frequently asked questions in the following technical areas: Scope and identifying a lease Leases embedded in service arrangements Capitalization policies Allocating consideration in the contract Topics discussed by the FASB at its November 30 Board Meeting Additionally, questions are frequently asked about operationalizing the standard. Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 3

Polling question #1 Which best describes your organization? Primarily a lessee Primarily a lessor Both lessee and lessor Auditor User None of the above Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 4

Identifying a lease Leases embedded in service arrangements Principle: If PP&E is identified, must determine whether customer controls right to use it Examples of contracts to consider: Manufacturing supply agreements Power purchase agreements Oil and gas drilling contracts Shipping contracts Cable television services Cloud-computing services Networking services Why it matters: Services Operating leases Capital leases On-balance sheet treatment Off-balance sheet treatment ASC 842 ASC 840 Identify your leases! Many arrangements that contain accounting leases will not say lease on the cover. Expect increased scrutiny around lease identification under ASC 842. Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 6

Scope considerations Capitalization policies Companies can use a reasonable capitalization threshold when applying the recognition guidance under ASC 842 Do not default to existing PP&E capitalization thresholds Existing threshold does not incorporate: Effect of additional asset base Liability recognition Reasonable approaches include: Capitalization threshold set as the lesser of: Capitalization threshold for PP&E, inclusive of ROU assets Recognition threshold for liabilities, inclusive of lease liabilities Recognize all lease liabilities, but, subject to threshold, expense amounts associated with the ROU asset Choose one approach, apply consistently, and consider disclosures Basis for conclusions Paragraph BC122: Entities will likely be able to adopt reasonable capitalization thresholds below which lease assets and lease liabilities are not recognized Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 7

Capitalization policies Example Key facts Lease of a machine Lease term: 5 years ROU asset = $3,260 Lease liability = $3,260 Lessee considers the following to identify a threshold for its leases Gross balances of its ROU assets ($3,260) and lease liabilities ($3,260) Disclosures that would be omitted if certain leases were not recognized Internal controls needed to apply and monitor the threshold Materiality considerations in SAB Topic 1.M Lesser of approach Threshold for PP&E, including ROU assets = $3,500 Threshold for liabilities, including lease liabilities = $3,000 ROU asset and lease liability ($3,260) > recognition threshold for liabilities ($3,000, the lower of the two) Lessee should recognize the ROU asset and lease liability Recognize all liabilities approach Threshold for PP&E, including ROU assets = $3,500 ROU asset ($3,260) < capitalization threshold for PP&E ($3,500) Lessee should expense amounts associated with the ROU asset Lessee should recognize the lease liability Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 8

Polling question #2 How prepared is your organization to comply with the new lease accounting standard? Extremely prepared Very prepared Somewhat prepared Not too prepared Not at all prepared Don t know/na Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 9

Contracts that contain multiple components Allocating consideration in the contract The basic process is similar for lessees and lessors Step 3 Allocate consideration in the contract to each component Step 2 Determine consideration in the contract Step 1 Identify the components in the contract Items that transfer a good or service to the lessee are lease and nonlease components Administrative items or reimbursements of lessor s costs are not components Lessees: lease payments Lessors: lease payments, plus variable consideration under ASC 606 that does not relate to the lease component Lessee practical expedient to not separate lease and nonlease components Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 11

Allocating consideration in the contract Lessor example Lessee X enters into a 5-year gross lease of a building from Lessor Y. Fixed annual lease payments are $35,000 and the contract outlines the following payments for rent, property taxes, common area maintenance ( CAM ), and insurance (in which Lessor Y is the named insured): Items Contractual Payment Rent $20,000 CAM $7,000 Property taxes $5,000 Insurance $3,000 Total $35,000 Question 1: How many components are there in the contract? Question 2: What is Lessor Y s consideration in the contract? Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 12

Allocating consideration in the contract Lessor example (cont.) Answer 1: Two 1. Lease component, for the right to use the building 2. Nonlease component, for the maintenance services (i.e., CAM) Property taxes and insurance are not components in the contract. Answer 2: $35,000 Lessor Y allocates $35,000 on the basis of standalone selling price ( SASP ) for two components. Assume that the SASP for rent, excluding property taxes and insurance, is $21,500. Further, assume that the standalone selling price for CAM is $7,650. Component SASP % of Total SASP Allocation Rent, excluding taxes and insurance $21,500 73.8% 73.8%*$35,000 = $25,830 Maintenance service $7,650 26.2% 26.2%*$35,000 = $9,170 Total $29,150 100.0% $35,000 Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 13

Polling question #3 Which best describes your organization s likely lease accounting implementation timeline? Early adopt, public company adopting faster than timeline mandated by regulators for publicly traded companies Early adopt, private organization adopting faster than timeline mandated by regulators for privately held organizations Adopt on schedule, public company adopting on timeline mandated by regulators for publicly traded companies Adopt on schedule, private organization adopting on timeline mandated by regulators for privately held organizations Don t know/na Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 14

Measurement of sales-type and direct financing leases Commencement loss resulting from significant variable payments Sales-type or direct financing lease with significant variable payments may result in lessor recognizing a loss at commencement Net investment in the lease does not include variable lease payments If net investment < carrying amount of leased asset, a loss is recognized A book loss, but not an economic loss Examples of arrangements that may be affected: November 30 FASB Board Meeting FASB considered, but ultimately rejected, possible solutions: 1. Including variable lease payments in measurement of net investment subject to a constraint (by reference to ASC 606) 2. Negative discount rate FASB clarified to use a zero discount rate Renewable energy (e.g., wind or solar) power purchases Oil and gas gathering and processing Retail real estate Medical devices with consumables Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 16

Commencement loss resulting from significant variable payments Example Payments are entirely based on usage Sales-type lease 100% variable Contractual terms Lease term 5 years Year Net investment Interest income Variable lease revenue Profit and loss Fair value 120.00 Carrying amount 100.00 Annual fixed lease payments - Rate lessor used to price the lease 1 6.4% Required discount rate 0.0% Estimated residual at end of lease term 50.00 0 50.00 - - (50.00) 1 50.00-20.00 20.00 2 50.00-20.00 20.00 3 50.00-20.00 20.00 4 50.00-20.00 20.00 1 The lessor has significant insight into the lessee s usage of the asset and has priced the lease expecting to receive $20 annually in variable payments. 5 50.00-20.00 20.00 Total 100.00 50.00 Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 17

Polling question #4 How concerned are you about your organization s ability to implement the new lease accounting standard by the chosen or required date? Very concerned Somewhat concerned Not concerned Don t know/na Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 18

Impairment of the ROU asset Subsequent measurement November 30 FASB Board Meeting In the carrying amount of the asset group: Include ROU asset Include lease liability In the undiscounted cash flows under ASC 360: Include principal component of lease payments Exclude interest component of lease payments Entity could apply accounting policy election to include interest component. Example Asset Group 12/31/2016 1/1/2019 Working capital assets 200,000 200,000 Operating lease ROU asset 0 150,000 Leasehold improvements 200,000 200,000 Accounts payable (150,000) (150,000) Operating lease liability 0 (150,000) Total carrying amount [A] 250,000 250,000 Future undiscounted cash in flows 575,000 575,000 Future undiscounted cash out flows (350,000) (300,000) Future undiscounted cash flows [B] 225,000 275,000 Impaired? [B] < [A]? Yes No Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 19

Impairment of the ROU asset Transition considerations November 30 FASB Board Meeting Considering whether the ROU asset is impaired in transition Do not revisit, or reallocate to the ROU asset, impairment losses of an associated asset group prior to the effective date If impaired, lessee loses the straightline treatment of total lease expense Transition questions still open for resolution Timing and recognition of impairment in transition How hindsight is applied to impairment Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 20

Lease term and subleases Impact of sublease renewals on head lease term Entity A Head lessee Sublessor Head lease Entity B Head lessor November 30 FASB Board Meeting Head lease Entity A leases asset from Entity B Sublease Entity A subleases asset to Entity C Sublease* Entity C Sublessee *Are the renewal options reasonably certain of being exercised? If a sublessee (C) has contractual renewal options on a leased asset, does the head lease term automatically include all periods covered by those renewal options? Not necessarily. Head lessee (A) should assess whether renewals in control of the sublessee (C) are reasonably certain of exercise. Head lessee should monitor to consider whether reassessment of the head lease term is needed. Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 21

Polling question #5 How easy or difficult do you think it will be for your company to implement the new lease accounting standard? Extremely easy Somewhat easy Neither easy nor difficult Somewhat difficult Extremely difficult Don t know/na Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 22

Implementation of the new leases standard Fundamental elements of a successful strategy Governance/stakeholder alignment Technology Data/Embedded Leases Processes and Internal Controls ASC 842 - Leases Accounting/Tax Policy Training and Communications Transition Dual Recording Maintenance Effective for public business entities for fiscal years beginning after December 15, 2018 and interim periods therein; for all other entities effective for fiscal years beginning after December 15, 2019 and interim periods thereafter Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 24

Technology solutions Functionality considerations Extent of functionality: accounting and lease administration Internal controls/workflow management Transition and steadystate accounting Data abstraction, migration, and interfaces Technology Solution Ongoing maintenance to technology Master Agreements/Portfolio Approach Interaction with other GAAP IFRS, ASC 740, ASC 360 Disclosures Clearly documented detailed business requirements can accelerate an efficient vendor arrangement process Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 25

Polling question #6 Will your organization invest in technology to comply with the new lease accounting standard? No current software should be adequate Yes software upgrades will be necessary Yes new software will be necessary Don t know/na Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 26

Lease abstraction and migration Considerations around the data challenge Portfolio approach Short-term lease exemption Materiality considerations Decisions around practical expedients Existing Electronic Data Resourcing Considerations Leveraging existing systems and electronic data to the fullest extent possible: Data gap analysis Data migration plans Leveraging third-party data Accelerate abstraction of data from documents through use of abstraction software Optical character recognition Machine learning Analytics Accelerate abstraction through software Accounting knowledge Experience leveraging technology Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 27

Internal control considerations Complexities throughout the organization The new lease standard introduces additional considerations around a company's internal control structure: Increased focus around internal controls regulators and other stakeholders New balances and disclosures subject to internal controls Complexity of requirements of the New Lease Accounting Standard Other internal control considerations Data and access management Workflow management with approvals/reviews Audit trails Segregation of duties Technology/processing Version control Re-assessment/modifications Internal controls performed by service organization Lease Cycle Lease modification (renew, cancel, modify) Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 28

Illustrative leases roadmap Key steps to completing a successful implementation Opening Balance Sheet* Effective Date* Comparative Period 1 Comparative Period 2 Area Q1 2017 Q2 2017 Q3 2017 Q4 2017 Q1 2018 Q2 2018 Q3 2018 Q4 2018 Ongoing Program Management Initial planning and assessment Project tracking, status reporting, and communications Data collection Validation and readiness activities Execute data gathering efforts Ongoing data maintenance Process & Close, Consolidate, Report Define new lease work flows Design and implement new reports, controls, and processes Systems & Interfaces Develop nearterm and longterm system strategy Vendor Selection Process Develop and implement long-term repository User Acceptance testing Potential Implementation of solution enhancements Technical Accounting & Tax Considerations Accounting policies/whitepapers Tax considerations Development of final conclusions Development of balance sheet and income statement impact; draft disclosures Training Develop training plan Execute training plan *Assumes calendar year US GAAP public company Activities performed in planning stage Critical activities (highly time sensitive) Activities performed in execution stage Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 29

Next steps Common areas of near term focus Understand lease landscape/data gap analysis Implementation roadmap/workplans Conclude on practical expedients and transition approach Business requirements development Vendor selection process, if applicable Data/embedded lease framework and approach Governance/Communications Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 30

Polling question #7 Which will pose the largest implementation challenge for your company s lease accounting standard compliance efforts in the next 12 months? Complying with both IASB and FASB standards simultaneously IT system upgrades Collecting necessary data on all organizational leases in a centralized, electronic inventory Developing and instituting processes to evaluate quarterly adjustments/reassessment for the balance sheet and P&L as required Educating investors and internal stakeholders on the rules impacts to financial statements Don t know/na Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 31

Join us June 27 at 2 p.m. ET as our Financial Reporting series presents: Quarterly accounting roundup: An update on Q2 2017 important developments Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 33

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Contact information James Barker Partner Deloitte & Touche LLP jabarker@deloitte.com Connect with me on LinkedIn Kristin Bauer Partner Deloitte & Touche LLP kbauer@deloitte.com Connect with me on LinkedIn Sean Torr Managing Director Deloitte & Touche LLP storr@deloitte.com Connect with me on LinkedIn Taylor Paul Manager Deloitte & Touche LLP tapaul@deloitte.com Connect with me on LinkedIn Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 35

Acronyms used in presentation ASC Accounting Standards Codification ASU Accounting Standards Update DFL Direct Finance Lease FASB Financial Accounting Standards Board GAAP Generally Accepted Accounting Principles IFRS International Financial Reporting Standards PP&E Property, Plant and Equipment P&L Profit and Loss ROU Right of Use SAB Staff Accounting Bulletin Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 36

Resources Heads Up Frequently Asked Questions about the FASB s New Leases Standard Heads Up FASB s New Standard Brings Most Leases Onto The Balance Sheet Retail & Distribution Spotlight Leases Refashioned Consumer & Industrial Products Spotlight Proposed Changes to Lessor Accounting: The Lessor of Two Evils Power & Utilities Spotlight Shedding Light on the Proposed Leases Standard Oil & Gas Spotlight Production Phase of the Leases Standard Complete Real Estate Spotlight A Walk-Through of the FASB s New Leases Standard Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 37

This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation. Copyright 2017 Deloitte Development LLC. All rights reserved. FAQs about the New FASB Leases Standard: You re Not Alone 38

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