The Dbriefs Financial Reporting series presents: Leases: A Comprehensive Update on the Joint Project Bob Uhl, Deloitte & Touche LLP Trevor Farber, Deloitte & Touche LLP James Barker, Deloitte & Touche LLP Beth Young, Deloitte & Touche LLP April 3, 2013
Agenda Significant provisions Lessee accounting Lessor accounting Other considerations Question and answer
Keep in mind This webcast does not provide official Deloitte & Touche LLP interpretive accounting guidance Check with a qualified advisor before taking any action See later slides for information on obtaining written summaries of issues discussed today 1
Learning objective To enhance participants understanding of important accounting issues and developments pertaining to recent actions of the FASB, IASB and EITF. 2
Poll question #1 Are you a financial statement preparer, user, auditor, or other interested party? Preparer User Auditor Other
Significant Provisions
Overview and timing 6 Issued in August 2010 Original Exposure Draft (ED) Comment period ended December 2010 Over 750 letters received Revised ED Expected to be issued second quarter 2013 Final Standard Expected to be issued 2014 Effective Date Expected to be no sooner than 2017 3
Scope Overall similar to current U.S. GAAP Exclude: Leases for the right to explore for or use minerals, oils, natural gas, and similar nonregenerative resources Leases of biological assets, including timber Intangible assets 4
Short-term leases Maximum possible lease term, including options to renew, that is 12 months or less Short-term leases would include leases that: Are cancellable by both the lessee and lessor with minimal termination payments, or Include renewal options that must be agreed to by both the lessee and lessor Current operating lease treatment for lessee and lessor Elective in nature by underlying asset class 5
Definition of a lease A contract in which the right to use a specified asset (the underlying asset) is conveyed, for a period of time, in exchange for consideration Specified asset Explicitly or implicitly identified Substitution rights must be considered Control Ability to direct the use and receive the benefit from use Rights to substantially all economic benefits from use over the lease term Taking all of the output will no longer be determinative 6
Poll question #2 Do you agree with the revised definition of a lease? Yes No Not sure
Lease term Noncancellable period + renewal period(s) for which lessee has significant economic incentive to exercise renewal options Contract Factors The terms included in the lease agreement Asset Factors Specific characteristics of the underlying asset Entity Factors The historical practice of the entity, management s intent, and common industry practice Market Factors Market rentals for comparable assets 7
Lease payments Fixed lease payments Include lease payments that are to be made over the lease term For example, payments required in a period that follows a termination option are used to measure lease assets and liabilities if it is determined that the lessee has a significant economic incentive to not exercise the termination option Variable lease payments - only included if: In-substance fixed payments Payments based on index or rate 8
Lease payments Residual value guarantees (RVGs) Lessees Include the difference between the expected residual value and the guaranteed residual value Lessors Certain RVGs considered lease payments. All RVGs can be considered in evaluating the impairment of residual assets Purchase options Recognition, measurement and classification Termination penalties Treated consistently with the determination of the lease term 9
Contracts that contain lease and nonlease components Lessee Allocate transaction price based on whether or not the purchase price is observable If purchase price of each component is observable based on relative purchase price of individual components If purchase price of one or more components, but not all, is observable based on a residual method If none of the purchase prices are observable account for the entire transaction as a lease Lessor Allocate transaction price on a relative standalone selling price basis (consistent with the revenue proposal) Estimate standalone selling price if not observable Expected cost-plus margin, adjusted market assessment, or residual method (if price is highly variable or uncertain) are acceptable estimation methods 10
Discount rate Lessee Rate the lessor charges the lessee when available; otherwise, its incremental borrowing rate Lessor Rate the lessor charges the lessee, which could be: Lessee s incremental borrowing rate Rate implicit in the lease Yield on the property for property leases Discount rate should be reassessed when there is a change in the lease payments 11
Poll question #3 True or False: When determining the lease term, an entity should consider contract-related factors at both the inception of the lease and each period (reassessment). True False
Lessee Accounting
Lessee accounting Initial measurement Right-of-use asset Present value (PV) of lease payments + lessee s initial direct costs Initial direct costs: Incremental costs directly attributable to negotiating and arranging a lease Recognize lease incentives as a reduction in the right-of-use asset Lease liability PV of lease payments Subsequent measurement Right-of-use asset Amortized cost: Method of amortization depends on nature of underlying asset (see slides that follow) Impairment: Refer to existing standards (ASC 360) Lease liability Amortized cost: Use the effective interest method 12
Lessee accounting A lessee s determination of the appropriate expense recognition pattern would be based on whether the lessee acquires and consumes more than an insignificant portion of the underlying asset Yes Is the leased asset property? No Lease term is a major portion of asset s remaining economic life OR PV of fixed lease payments accounts for substantially all of the FV Lease term is insignificant to asset s total economic life OR PV of fixed lease payments insignificant relative to asset FV? Yes No Yes No Financing Approach Straight-line Expense Approach Straight-line Expense Approach Financing Approach 13
Classification of lease components Analyze agreement to determine if separate accounting is required for lease components Use of the asset depends on other assets that are readily available to the entity Use of the asset is interrelated with other assets identifiable in the contract Classification should be based on the primary asset of the lease component Land and building elements of a property lease would not need to be assessed separately 14
Poll question #4 Do you agree with the two model approach that the boards have proposed for lessees? Yes No Not sure
Lessee accounting 15
Lessee accounting Constituents concern about income statement effect being inconsistent with lease economics 16
Reassessment of lease payments 17
Lessor Accounting
Lessor accounting Receivable and residual Operating lease Derecognize Underlying asset Recognize Lease receivable Residual asset Defer profit relating to the residual asset (netted with residual asset) Continue to recognize the underlying asset and recognize lease income over the lease term 18
Lessor accounting A lessor s determination of the appropriate expense recognition pattern would be based on whether the lessee acquires and consumes more than an insignificant portion of the underlying asset Yes Is the leased asset property? No Lease term is a major portion of asset s remaining economic life OR PV of fixed lease payments accounts for substantially all of the FV Lease term is insignificant to asset s total economic life OR PV of fixed lease payments insignificant relative to asset FV? Yes No Yes No Receivable and Residual Approach Operating Lease Approach Operating Lease Approach Receivable and Residual Approach 19
Poll question #5 Variable payments are included in a lessee and lessor s calculation of lease payments when: They are based on an index or a rate They are in-substance fixed payments Both of the above None of the above
Lessor accounting A manufacturer leases a piece of its equipment to a lessee. The leased equipment has a carrying amount of $20,000 and a fair value of $24,000 at lease commencement. The terms of the lease are as follows: 20
Lessor accounting
Other Considerations
Other considerations Lease commencement Recognition, measurement and classification Build to suit transactions The guidance in ASC 840-40 related to a lessee s involvement with construction (previously EITF 97-10) will not be carried forward Subleases Head lease account for assets and liabilities in accordance with guidance for lessees Sublease account for assets and liabilities in accordance with guidance for lessors 22
Other considerations Sale and leaseback transactions Existing guidance will not be carried forward Entities should look to the guidance on revenue recognition to determine whether the conditions of sale are met Consider whether the seller/lessee has the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset If revenue recognition conditions are met, a whole asset approach would be used in accounting for the transaction If consideration is fair value, gains and losses would not be deferred 23
Transition Lessee 24 Full retrospective approach OR Modified retrospective approach Operating leases existing at beginning of earliest comparative period presented: Finance Method Recognize lease liability at PV of remaining lease payments Recognize right-of-use asset as a proportion of lease liabilities Recognize difference in retained earnings Reverse straight line accrual Straight Line Method Recognize lease liabilities at PV of remaining lease payments Recognize right-of-use asset at the amount of the related lease liability Reverse straight line accrual Capital leases existing at the beginning of earliest comparative period presented: Apply existing guidance for recognition and measurement purposes Reclassify carrying amount of lease assets and liabilities as rightof-use assets and lease liabilities
Transition Lessee 25
Poll question #6 True or False: Under the proposal, a lessee that enters into a sublease would look to the guidance for lessors to determine how to account for the transaction? True False
Transition Lessor Full retrospective approach OR Modified retrospective approach Operating leases existing at beginning of earliest comparative period presented: Receivable and Residual Method Recognize lease receivable asset measured at present value of remaining lease payments Recognize residual asset based on the proposed model Derecognize the leased asset Sales-type and financing leases existing at the beginning of earliest comparative period presented: Apply existing guidance for recognition and measurement purposes Reclassify the amounts recorded in accordance with the proposed presentation requirements 26
Operational and implementation challenges Systems New systems requirements Identification lease arrangements and capturing relevant data Changes to internal controls Business Changes Compliance with debt covenants Educating analysts Lease vs. buy decisions Financial Reporting Increased judgments Right-of-use assets will need to be evaluated for impairment Tax complexities Increased disclosures 27
Poll question #7 Do you or your organization plan to comment on the exposure draft? Yes No Haven t decided
Question and answer
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Contact info Bob Uhl James Barker Trevor Farber Beth Young ruhl@deloitte.com jabarker@deloitte.com tfarber@deloitte.com eyoung@deloitte.com
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