Accounting for Leases Understanding the New Standards Introduction - - PowerPoint PPT Presentation

Accounting for Leases

Understanding the New Standards

Introduction

• Issued February 25, 2016

Introduction

• FASB Chair Russell Golden stated:

– “The new guidance responds to requests from investors and other financial statement users for a more faithful representation of an

• rganization’s leasing activities. It ends what

the U.S. Securities and Exchange Commission and other stakeholders have identified as one

• f the largest forms of off-balance sheet

accounting, while requiring more disclosures related to leasing transactions.

Introduction

• FASB Chair Russell G, Golden stated: (cont)

– The guidance also reflects the input we received during our extensive outreach with preparers, auditors, and other practitioners, whose feedback was instrumental in helping us develop a cost-effective, operational standard.”

Introduction

• Core concept:

– An entity should recognize assets and liabilities arising from a lease – For lessees, all leases over 12 months go on the balance sheet

• Under this pronouncement lessees would apply a

right-of-use model

Introduction

• Definition of a lease

– “A contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment”

Introduction

• Nonpublic Company Breaks

– Discount rate

• May use the risk-free rate for all

FASB Codifications Sections Affected

• Leases- 840, Old
• Leases- 842 New

Who is Affected

• This pronouncement would affect most any entity

that enters into a lease

• This applies to all leases, including subleases

Who is Affected

• Exceptions would include

– Leases of biological assets – Leases of intangible assets – Leases to explore for natural resources – Leases of inventory – Leases of assets under construction

Effective Date

• Public

– Fiscal years beginning after December 15, 2018

• Calendar 2019
• Others

– Fiscal years beginning after December 15, 2019

• Calendar 2020
• Interims after December 15, 2020

Transition

• Leases for lessors and lessees are to be

measured and recognized at the beginning of the earliest period presented using a modified retrospective approach

Transition

• This will include many practical expedients for

leases already in place – These will still be placed on the balance sheet by a lessee, but will not have to be reassessed for classification, unless modified

Reasons for the Standard Change

Reasons

• Users wanted more transparency
• Many leases represented off-balance

sheet liabilities

• Many leases are structured to keep them off the

balance sheet

• The primary element of this update is that leases

will now go on the balance sheet

Reasons

• This reduces comparability
• Footnote disclosures are minimal as well
• There will also be more disclosures
• As a result, many users have to make

approximations on their own to try to obtain information necessary for comparisons

Reasons

• The root of this issue is operating leases on the

books of lessees – The majority of leases are operating leases – For 2005 the SEC reported that SEC companies had $1.25 trillion in off-balance sheet leases – Thus, the SEC made the push for change

Reasons

• Costs of implementation are not considered to

be significant

• The core guidance for lease accounting has

not changed – Thus, information needed to comply already exists

• After much outreach and feedback, the FASB

decided that many aspects should remain the same

Reasons

• The IASB issued IFRS 16 for leases as well, but

there are many differences from that standard although it was the goal for convergence – The major consideration was cost

History

History

• Prior guidance originated from FASB 13
• Began project in 2006 and solicited input from a

variety of stakeholders – Public companies – Private companies – Not for profit entities

• Discussion included

– Costs – Implementation issues

History

• Outreach

– 14 US fieldwork meetings

• Wide range of industries

– 15 preparer workshops

• Over 90 organizations represented

– 15 public roundtables with over 180 representatives

• 2 were focused on

private and not-for-profit companies

History

• Outreach

– Meetings with over 500 financial statement users – 200 meetings with preparers and users

• Including private and not-for-profit

– 1,740 collective comment letters on the three documents

History

• Consensus

– Preparers and auditors decided the new update was the lowest cost option

History

• Many concerns about the exposure drafts

– Recognition, measurement and presentation was to be based on whether the lessee is expected to consume more than an insignificant portion of the economic benefits

• f the asset
• Thus there would be two categories for

lessee and lessors

• This was primarily

based on the nature

• f the asset

History

• Many concerns about the exposure drafts (cont.)

– Recognition, measurement and presentation was to be based on whether the lessee is expected to consume more than an insignificant portion of the economic benefits of the asset (cont.)

• Type A

– Lessee consumes more than an insignificant portion of the asset – Most assets other than real property

• Type B

– Lessee does not consume more than an insignificant portion of the asset – Most leases of real property

History

• Many concerns about the exposure drafts (cont.)

– Under the first exposure draft, the lessor would use a performance obligation approach or derecognition approach

History

• Many concerns about the exposure drafts (cont.)

– This would have been based on exposure to significant risks or benefits associated with the underlying asset either during or after the expected lease term

• Performance obligation approach
• The following items would have been

recognized in the statement of financial position: – A right to receive lease payments – The underlying assets – A lease liability

History

• In response the FASB made the following

final decisions – A lessee model with two lease types

• Finance
• Operating

– Classification approach similar to the current one

• This should reduce

extra work – Lessor accounting will remain mostly unchanged

History

• In response the FASB made the following

final decisions (cont.) – Exception for leases less than 12 months – The guidance may be applied to a portfolio level for similar leases – Simplified measurement for variable and

• ptional payments and reassessments

– Simplified recognition and measurement for operating leases for a lessee

History

• In response the FASB made the following final

decisions (cont.) – Lease and nonlease components may be separated with a standalone cost for each for lessees – Provides guidance for application of the revenue standard for sales and leaseback arrangements – Simplified disclosures by removing reconciliation disclosures

History

• In response the FASB made the following final

decisions (cont.) – Simplified transition rules – Use of risk-free rate for private companies and not for profit entities – Long period for implementation

History

• In 2009 a discussion paper was issued
• In 2010 an exposure draft was issued
• This was rescinded in 2011
• In 2013 a second exposure draft was issued

Why This is Better

Why This is Better

• Better presentation of rights and obligations

– Requires recognition of the assets and liabilities

• More useful disclosures
• Better comparability

Why This is Better

• Better lease definition

– Better integration with other GAAP

• Better disclosure of lessor credit and asset risk

related to leases

• Reduces the opportunity to structure a lease to

keep it off the balance sheet

Overall Concepts

Identifying the Lease

Identifying the lease

• Does the contract contain a lease?
• Does it convey the right to control the use of the

asset for a period of time for consideration?

• Period of time may also be described as amount
• f use
• Can the customer obtain substantially all the

economic benefits of the asset?

• Can the customer direct the

use of the asset?

Lease Determination Chart

• Is there identified asset?

– No- No lease – Yes- Continue

Lease Determination Chart

• Does the customer have the right to substantially

all the economic benefits of the asset during the term? – No- No lease – Yes- Continue

Lease Determination Chart

• Who has the right to direct how the asset will be

used during the term? – Supplier- No lease – Customer- Lease – Neither (the purpose is predetermined), continue

Lease Determination Chart

• Can the customer operate the asset during the

term without the supplier rightfully changing the

• perating instructions?

– Yes- Lease – No- Continue

Lease Determination Chart

• Did the customer design the asset such that it

predetermines the purpose for the term? – No- No lease – Yes- Lease

Lease Classification

Lease Classification

• Lessee finance lease and lessor sales-type lease

– Must meet one of the following criteria:

• Ownership transfers to the lessee by the end
• f the lease term
• There is an option that the lessee is

“reasonably certain” to exercise

• The lease term is for the major part of the

remaining economic life of the asset – If it is near the end of the life, then do not use this criterion

Lease Classification

• Lessee finance lease and lessor sales-type lease

(cont.) – Must meet one of the following criteria: (cont.)

• The present value of the lease payments and

residual value guaranteed by the lessee is equal to or exceeds the fair value of the asset

• The nature of the asset

is such that it has no alternative use to the lessor at the end of the lease term

Lease Classification

• For a lessee not meeting the criteria for finance

– It is operating

Lease Classification

• For a lessor not meeting the criteria for sales-type,

it will be a direct financing lease if BOTH of the following apply: – The present value of the lease payments and residual value guaranteed by the lessee AND any other third party is equal to or exceeds the fair value of the asset – It is probable the lessor will collect enough to satisfy a residual value guarantee

Lease Classification

• For the lessor, if it is not sales-type or direct

financing, it is operating

Lease Classification

• Nonlease Components

– Nonlease components of a contract will need to be separated from lease components and not accounted for under the lease provisions

• These will accounted for under other topics

Lease Classification

• Nonlease Components (cont.)

– Lessees may elect a practical expedient where they elect a policy to not separate the nonlease components

• In this case, the entire contract will be

accounted for as a lease

Disclosures

Disclosures

• New qualitative and quantitative disclosures are

required for both lessees and lessors

Main Differences from Current GAAP

Definitions

Definitions Removed

• Bargain purchase option
• Bargain renewal option
• Capital lease

Definitions Removed

• Contingent rentals
• Estimated economic life
• Fair value of leased property
• Interest rate implicit in the lease
• Noncancellable lease term

New Definitions

• Commencement date of the lease

– Date the asset is available for use by the lessee

New Definitions

• Contract

– Agreement between parties that creates enforceable rights and obligations

New Definitions

• Customer

– A party who contracts goods or services for consideration in ordinary activities

New Definitions

• Finance lease

– A lease meeting the criteria for lessees

New Definitions

• Incremental borrowing rate

– Rate a lessee would pay to borrow on a collateralized basis with

• Similar term
• Amount equal to the lease payments
• Similar economic environment

New Definitions

• Lease

– Contract that conveys the right to control use

• f an identified asset for a period of time in

exchange for consideration

New Definitions

• Lease payments

– Fixed payments less incentives paid to the lessee – Variable lease payments depending on an index

• r rate initially measured using the rate at the

commencement date – Purchase option price is reasonably certain to be exercised

New Definitions

• Lease payments (cont.)

– Penalties for terminating if the lease term reflects the exercising of the termination option – Fees paid by the lessee to the owners for a special purpose entity to structure the transaction – Probable amounts owed under a residual guarantee

• Applies to the lessee only

New Definitions

• Lease term

– The noncancellable period the lessee has the right to use the asset plus

• Option periods for which the lessee is

reasonably certain to exercise

• Termination option periods for which the

lessee is reasonably certain NOT to exercise

• Option periods to extend

controlled by the lessor

New Definitions

• Lessee

– Entity that enters into a contract to obtain use

• f an asset for a period of time

for consideration

New Definitions

• Lessor

– Entity that enters into a contract to allow the use of an asset for a period of time for consideration

New Definitions

• Minimum lease payments

– Payments the lessee is obligated or can be required to make other than

• Contingent rentals
• Guarantee by the lessee of the lessor’s debt
• Lessee’s obligation to pay executory costs

related to the property – Insurance – Maintenance – Taxes

New Definitions

• Operating lease

– Any lease other than financing for a lessee – Any lease other than sales-type or direct financing for a lessor

New Definitions

• Underlying asset

– The asset in a lease that has had the right to use conveyed to a lessee

New Definitions

• There were also additions and modifications to

align with the revenue recognition standard