Session 2.08

“The Lease Accounting Changes Are Coming”

The Headlines
• “$1.3 trillion dollars is expected to be placed on the balance sheet by public companies alone”
– Securities and Exchange Commission
• “Reported debt load will be increased by 58% on average” –
PWC and Erasmus University

Learning Objectives
• Review the latest FASB changes being considered and upcoming milestones in the approval cycle.
• Understand the pros and cons of leasing and owning, considering the proposed FASB changes.
• Discuss what effect the FASB rule changes will have on the financial picture of your company.
• Learn what terms you should seek when negotiating leases to best position your portfolio given the proposed FASB changes.

Meet Our Presenters
Mark Ellis – Director, Global Facilities & Real Estate - Tekelec
Portfolio manager responsible for 26 leased locations around the globe completing over 75 transactions in his six years in the position. The substantial leasing profile within the portfolio has required him to follow and be up-to-date on the proposed accounting rules
Doug Moxley – Vice President of Finance - Xirrus
Doug has over 15 years of experience serving at the highest levels in Finance organizations for technology companies. His experience in both public and private sectors allows for a full understanding of the accounting implications of the upcoming changes
Michael Billing – Executive Vice President – Jones Lang LaSalle
Michael has over 18 years of professional services and client advisory experience leading to his current role as Jones Lang LaSalle’s Lease Accounting Project Director with responsibility for all activities related to the proposed lease accounting changes.

Background of Proposed IASB/FASB Rule Changes
• FASB and the IASB are proposing new accounting rules in an effort to improve transparency
• Exposure draft is scheduled to be published during Q2 2013, final standard is expected to be announced at the end of 2013 or early 2014, with changes likely to be effective no earlier than 2016; however, due to financial reporting rules, clients will have to report two years of comparative financial statements at the implementation date, and there will be no grandfathering
• Eliminates distinction between operating and financing/capital leases with all leases going on balance sheet - lessee to recognize an asset representing its right to use the leased asset for the lease term and a liability to make payments
• For some leases (significant scrutiny on real estate leases > 10 years), expense to be accelerated , unlike current lease accounting straight-line methodology
• Proposed changes impact all leases – real estate and equipment
• Will impact all companies that report financials under either U.S. GAAP or IFRS
(International Financial Reporting Standards) – this is a global issue

Background of Proposed IASB/FASB Rule Changes
Proposed lessee model
• Lessee to recognize an asset representing its right to use the leased asset for the lease term and a liability to make payments
• Leases of property (land or a building —or part of a building—or both) expense using the straight-line approach (current methodology) unless the lease term is for the major part of the economic life of the underlying asset; or the present value of fixed lease payments accounts for substantially all of the fair value of the underlying asset
• Auditors will likely scrutinize leases > 10 years
• Non-property leases expense to be accelerated (akin to a loan amortization schedule), unlike current lease accounting straight-line methodology
• Proposed changes impact all leases – real estate and equipment

Background of Proposed IASB/FASB Rule Changes

Current Status of FASB Rule Changes
Timeline
Comprehensive overhaul of lease accounting standards under FAS 13 and IAS 17
– lessees and lessors, with an objective to capitalize all leases and create economic transparency

Lease vs. Own Considerations
• The criteria for deciding whether to lease or buy needs to be carefully re-examined
• With the new standard, balance sheets will grow from capitalization of operating leases
• But balance sheet management may still occur through lease structures and decisionmaking
•
Organizations should focus on capital strategy, operating requirements, flexibility, and economics
• Sale and leasebacks transactions - sales of property meeting criteria under revenue recognition standard will treated as sales with immediate profit and loss recognition regardless of leaseback – no deferred gain under U.S. GAAP
• Potentially eliminates capital efficiency benefits (ROA) of leasing
• Potentially shifts expense profile to below the EBITDA line
• Decisions will be based on economics, not accounting
-
Need to consider a company’s cost of capital

Effect on Accounting
Significant judgments equal increased workload and scrutiny

Effect on Accounting
Proposed accounting treatment

Effect on accounting
Balance Sheet Example
Current Assets
Non Current Assets
Total Assets
Current Standard
5,000
2,000
7,000
Recognition of
Leases under New
Standard
-
2,000
2,000
New Statndard
5,000
4,000
9,000
Current Liabilities
Current Portion of LT Debt
Total Current Liabilities
Long Term Debt
Total Liabilities
Equity
Total Liabilities and Equity
Debt to Equity
Debt Ratio
Current Ratio
3,000
500
3,500
-
400
400
3,000
900
3,900
1,000 1,600 2,600
4,500 2,000 6,500
2,500 2,500
7,000 2,000 9,000
1.80
0.64
1.43
2.60
0.72
1.28

Effect on accounting
Income Statement Example
Revenue
COGS
Gross Margin
Current Standard
15,000
7,500
7,500
Recognition of
Leases under New
Standard
-
-
-
New Standard
15,000
7,500
7,500
Operating Expenses (Rent) 6,000 (400) 5,600
Operating Income
Interest / Amortization Expense
Net Income Before Taxes
Income Taxes
Net Income
1,500 400 1,900
150 600 750
1,350 (200) 1,150
459 (68) 391
891 (132) 759
EBITDA
EBITDA / Revenue
1,500
10.0%
1,900
12.7%

Effect on accounting
Financial implications
• Balance sheets will grow significantly
• Net income will be diminished due to the higher reported lease expense, but
EBITDA will grow
• Geography of expense will move on the P&L – no more rent, just amortization and finance expense
• Change in key performance ratios such as leverage / cash flow may impact covenants
– Legacy agreements / fixing the gap
• Potential volatility in income statements
– At transition
– Ongoing due to continuous reassessment

Stakeholders Affected by Accounting Changes
Consider communication plan for key stakeholders:
• Shareholders
• Board of Directors
• Investment Analyst community
• Bank and other finance companies
• Business partners

Potential System Integration Issues
• Lease Accounting tools and ERP systems need to evolve in time to record results for current and final new rule sets when the interim period starts
• Expense algorithms are different
• Recording and tracking of right-of-use asset and liability to pay lease payments
• Many judgments will need to be memorialized for audit purposes

Transaction Lease Structuring
• Leases will likely focus on:
• Lease term
• Rent escalations
• Contingent rent
• Extension options
• If these are included in the lease, they may have to be recognized as part of the term, which could make a significant balance sheet impact, whereas today they aren’t
• Any other factors that will impact capitalized amount

Positioning your Lease Portfolio
Taking the right steps to prepare

Learning Objectives – Accomplished!
• Reviewed the latest FASB changes being considered and upcoming milestones in the approval cycle.
• Understand the pros and cons of leasing and owning, considering the proposed FASB changes.
• Discussed what effect the FASB rule changes will have on the financial picture of your company.
• Learned what terms you should seek when negotiating leases to best position your portfolio given the proposed
FASB changes

Questions & Answers
21

Track the Latest Developments and Information
Visit www.LeaseAccountingChanges.com
• Follow the Blog to get current information and perspectives
• Register and use impact calculator
• Download preparedness checklist
• Ask questions and get answers
• Read articles and perspectives
• Get info/updates regularly

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IFMA’s Facility Fusion.
Please evaluate this session at the registration kiosk or online at http://ceu.experient-inc.com/FFN131

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