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 organization’s leasing activities. It ends what the U.S. Securities and Exchange Commission and other stakeholders have identified as one of 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 of the asset • Thus there would be two categories for lessee and lessors • This was primarily based on the nature of 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 optional 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 of 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 operating 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
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