It s Back Accounting for Asset Leases the new way!

Controlling 2016 Conference September 12-15, 2016 in San Diego Kent Bettisworth presenting sessions on: Top 10 best practices for year-end closing in PS and AA Important revenue recognition changes are coming are you ready? http://controlling.erpcorp.com/ 3

Topics Overview ASC842 Leases (United States) IFRS16 Leases (International) US vs International differences Impact Next Steps Summary Start of first section: List the main points in your presentation and insert this slide at the start of each new topic. Move the highlighted box down for each new section. This divides your presentation into easy to follow sections. 4

Introduction Trillions of dollars in capital and operating lease assets will be added to balance sheets as right-to-use (ROU) assets starting with 2019 or earlier. Leasing is an important activity to finance and gain access to assets and reduce an organization s exposure to the risks of asset ownership. The current offbalance sheet accounting has been criticized for years. Finally, the accounting boards have converged on a new standard effective in 2019. This session will educate you on what this means for your company as a lessee. What are the new rules? How will US accounting differ from the rest of the world? What should my company do to prepare? 5

Poll 1. Does your company have an active project to implement the new Lease Accounting standard? Yes No 2. If yes, what stage are you in? Not started Initial evaluation Design Build Test 6

Overview of Terms ASC Accounting Standards Codification (US) Effective July 1, 2009; consolidated/organized US standards IAS International Accounting Standards Specific international accounting standards IASB International Accounting Standards Board IFRS International Financial Reporting Standards Convergence-related international standards prepared jointly by IASB and FASB organizations FASB Financial Accounting Standards Board (US) SEC Securities and Exchange Commission (US) Regulator of financial reporting for US stock exchange listed companies 7

Leases New Standards Approved A new standard was approved in Lease financing totaled $3.3 trillion in 2016 Existing standards lack clarity, comparability, and are complex Financial statement users often adjust for operating lease values IAS16 and ASC842 supersede IAS17 and ASC840, respectively The new standard: Ensures all assets and liabilities arising from leases are reflected in the financial statements Consistent with the conceptual framework definition of assets and liabilities Consistent with the new revenue recognition standard Hans Hoogervorst, IASB Chairman, Shining the Light on Leases, March 26, 2016 8

Topics ASC842 (United States) Model Key differences Example Transition Start of first section: List the main points in your presentation and insert this slide at the start of each new topic. Move the highlighted box down for each new section. This divides your presentation into easy to follow sections. 10

ASC842 Model Who is affected? 11 Any entity that enters into lease contracts except: Intangibles, oil & gas leases, biologic, inventory, nor under construction assets or, Less than 12 months term or apply capitalization threshold How do I apply the principle? Identify a lease at inception as operating or finance Identify a physical asset (can be implied) Right to control and direct the use Evaluate for embedded leases in service contracts Separate lease and non-lease components Record a right-of-use asset in PP&E at present value, plus amortization over the lease life, and a lease liability Identify the lease payments, term and interest rate

ASC842 Model specifics For Operating leases: 12 Recognize a single lease cost Calculated as interest + amortization Amortization = straight-line expense less interest for the period Allocated over the lease term on a straight-line basis Classify cash payments within operating activity cash flow For Finance leases: You will own the asset or have used the major part of the assets economic life Recognize interest on the lease liability separate from the amortization of the right-of-use asset Classify amortization within financing activities Classify interest payments within operating activity cash flow

ASC842 Key differences ASC842 (ASU2016-2) All leases added to balance sheet Operating and Finance leases are identified separately Finance lease if ownership transferred No 25%, 75%, or 90% bright lines Assess contracts for embedded leases Exclude non-lease components Contract contains a lease if asset is Controlled by lessee Physically identified Balance sheet valuation Asset and liability valued at net present value of lease payments over estimated term Operating lease is single lease expense (calculated as interest expense plus amortization) Finance lease is separate interest and amortization expenses ASC840 Current Land is considered separately Only if 25% of lease fair value Capital lease where Lease term > 75% of asset life Lease payment present value > 90% of asset fair value 13

ASC842 Example Operating Lease 14 http://www.ey.com/ul/en/accountinglink/publications-library-technical-line

ASC842 Example Finance Lease 15 http://www.ey.com/ul/en/accountinglink/publications-library-technical-line

ASC842 Example Operating vs Finance Lease 16 http://www.ey.com/ul/en/accountinglink/publications-library-technical-line

ASC842 Transition Early adoption allowed Modified retrospective Apply new guidance at beginning of earliest comparison period For annual and interim financial statements Practical expedient election for leases before effective date No need to reassess for embedded leases No need to reassess for operating versus finance No need to reassess for initial direct costs May elect to use hindsight in determining option lease terms 17

Topics International IFRS16 Model Key differences Example Transition Start of first section: List the main points in your presentation and insert this slide at the start of each new topic. Move the highlighted box down for each new section. This divides your presentation into easy to follow sections. 19

IFRS16 Model Who is affected? 20 Any entity that enters into lease contracts except: Intangibles, oil & gas leases, biologic, inventory, nor under construction assets or, Less than 12 months term or, Low value ($5000 suggested) How do I apply the principle? Identify a lease at inception Identify a asset (can be implied) Right to control and direct the use Evaluate for embedded leases in service contracts Record a right-of-use asset in PP&E at present value, plus amortization over the lease life, and a lease liability Identify the lease payments, term and interest rate

IFRS16 Key differences IFRS16 All leases add Right-of-Use asset and liability to balance sheet Except less than 12 months or, Low value In contracts, must separate leases from services No separate Finance lease category Asset and liability valued at net present value of lease payments over estimated term Right-of-Use asset is depreciated Lease liability is amortized Must identify a lease asset Can lessor substitute? Does lessee have control? IAS17 Current Not limited to PP&E (2-4) Land and building are considered separately (15) Unless land is immaterial (17) Finance (capital) lease where: Lease term extends over major part of asset life (10c, 21) Lease payment present value covers substantially all of asset fair value (10d) 21

IFRS16 Example 22 http://www.ey.com/publication/vwluassets/applying_ifrs_in_telecommunications_- _IASB_issues_new_leases_standard/$FILE/Applying-Leases-Telcos-June2016.pdf

IFRS16 Transition Must choose full or modified retrospective approach Applied to entire lease portfolio Not required to reassess existing contracts Full retrospective approach requires: Apply to all prior reporting periods as defined by IAS8 Accounting Policies, Changes in Accounting Estimates Adjust balance sheet at beginning of the earliest comparative period presented Modified retrospective approach requires: Recognize cumulative effect as an adjustment on effective date Can apply practical expedients on lease-by-lease basis 23

Topics Overview ASC842 Leases (United States) IFRS16 Leases (International) US vs International differences Financial Impact Next Steps Summary Start of first section: List the main points in your presentation and insert this slide at the start of each new topic. Move the highlighted box down for each new section. This divides your presentation into easy to follow sections. 24

US vs International Differences ASC842 Definition Separate guidance for finance and operating leases Land is treated as separate lease Generally is a physical asset Measurement No explicit low value (use capitalization threshold) Variable Payments Do not measure again Private companies guidance Statement of Cash Flows Interest is operating activity Amortization is financing Impairment follows FASB Transition Adopt early allowed IFRS16 Definition Does not separate finance and operating leases No requirement to separate land Not necessarily a physical asset Measurement Exempt low value of less than $5000 Allows alternative valuation bases Variable Payments Measure again if index rate changes No separate guidance for private companies Statement of Cash Flows Interest classed optionally as operating, investing, or financing activities Impairment follows IASB Transition Adopt early if also adopting new Revenue Recognition standard 25

27 Transition Dates

Who is affected? http://explore.leaseaccelerator.com/wp-content/uploads/2016/01/who-is-most-impacted-by-the-new-lease-accounting-standards-d.pdf 28

What is the Impact on Processes & Income Business processes Creates a high volume of new assets Value from present value calculations Income statement Lessee EBIDTA may improve Lease expense decreases Interest expense increases Amortization expense increases Lessor EPS timing changes Interest revenue may increase Longer lease life spreads out timing 29

What is the Impact on the Balance Sheet & Disclosures Balance sheet Lessee ROI reduced Right-of-use assets increase Debt covenants may be impacted Disclosure Operating leases removed from footnotes Replaced with extensive qualitative and quantitative explanations of judgement 30

Next Steps Establish a project team Who and what is their charter? Start communicating with affected stakeholders Investors, Employees, Lease Vendors Connect with FASB/IAS lease advisory groups Develop early assessment of impact on: Finance including tax impacts Processes including training Systems including new controls 32

Early Assessment Expert examination of classification changes Review existing leases for classification changes Do you have the right data to assess the new standard? Need to separate lease and non-lease components Estimate the financial effect of the change Acquisition and Liability value based on present value Amortized life based on longest life when considering renewal options What is the interest rate? Candidates for process improvement opportunities? Should you renegotiate certain operating leases? Should you eliminate inefficiency and automate hand-offs between purchasing/payables/receivables and fixed assets? How do you incorporate lease assets into the capital budget? 33

Implementation Assessment Identify who and the type of training required Business line, accountants, systems support Adapt lease management process and systems Is this process automated? What is the right system to manage lease assets? Can you use SAP s lessee simple asset lease functionality for short term? Identify the conversion method How many leases will reclassify? How many new lease assets are required? How to create new right-to-use assets and liabilities? What is the approach for transition leases? 34

SAP Solutions Review SPRO > Financial Accounting > Lease Accounting (Lessor) Lease accounting processes in SAP for lessor and lessee Master data New asset classes Review accounting principles Transactions Review for alignment with parallel ledger or parallel account for IFRS Cross-system integration Source: help.sap.com > SAP ERP Central Component > Financials > Financial Accounting (FI) > Lease Accounting (FI-LA for Lessor) SPRO > Financial Accounting > Asset Accounting > Special Valuation > Leasing (Lessee) 35

Other Solutions to Review Nakisa is supported and sold by SAP http://www.nakisa.com/lease-accounting-software Visual Lease software http://www.visuallease.com/fasb/ Lease Accelerator software http://explore.leaseaccelerator.com/products/leaseaccounting-software/ AMT Direct http://www.amtdirect.com/solutions/fasb-administration NOTE: Buyer beware! 36

Key Point to Take Home Assessment for Lease Accounting must start now! Establish your project team Stay up-to-date with FASB/IAS Lease implementation advice Learn the financial and process impact to your company sooner rather than later! Evaluate vendor solutions for robustness and fit with existing ERP system 38

Resources www.ifrs.org http://www.ifrs.org/current-projects/iasb- Projects/Leases/Documents/IFRS_16_project-summary.pdf www.fasb.org http://www.fasb.org/jsp/fasb/document_c/documentpage?cid=11761 67901010&acceptedDisclaimer=true www.iasb.org International Accounting Standards Board (IASB) www.iasb.org/ifrss/ifrs.htm International Financial Reporting Standards (IFRS) http://asc.fasb.org Accounting Standards Codification (ASC) www.sdn.sap.com/irj/bpx/ifrs SAP community forum for IFRS discussions and information 39

Questions Kent Bettisworth BETTISWORTH & ASSOCIATES, INC. 713-467-8374 kent@bettisworthassociates.com www.bettisworthassociates.com Q&A 40

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