The FASB Lease Accounting Project
Overview, Issues and Status
May 30, 2013
Agenda
• Timing
• What is the Project?
• Issues and Impacts
– Lessees
– Lessors
• Summary impacts and action plans
• Q&A
Project Timeline
ED
Issued
August
2010
Comment
Letters
Dec 2011
Outreach
Redeliberations
Jan 2011 –
September
2012
Comment
Draft New ED New ED To Letters
Issued
Now
Due
5/16/2013
9/13/13
Re-deliberate
Final
4 QTR 2013 Standard
& into 2014
2014
Timeline is not fixed
• Dependent upon number of comment letters and extent of redeliberations
• We expect a high volume of negative comment letters
• Effective date uncertain – likely to be 2017
Questions addressed by the Boards
What is a
lease?
What is
the lease
term?
What are
the lease
payments
?
How does
a lessee
allocate
cost?
How does
a lessor
recognize
income?
How to
account
for short
term
leases?
4
Definition of a lease
• A contract in which the right to use a specified
asset is conveyed, for a period of time, in
exchange for consideration
– Specified asset (PP&E plus certain types of
inventory like spare parts)
– Right to control the use of a specified asset
(different from current GAAP)
– No guidance on purchase vs. lease
5
Lease term
• Recognized lease term would include non-cancellable
period, plus any optional periods where there is a
significant economic incentive to extend (or not
terminate) the lease (virtually same as current GAAP)
• Purchase options – include on a basis consistent with
renewal options
– Assume exercise if significant economic incentive to
exercise exists
• Consider all factors (contract, asset, market and
entity based)
6
Lease payments
• Lease payments include:
–
–
–
–
Fixed payments (bundled services must be bifurcated)
Variable payments based on index or rate (e.g., CPI or LIBOR)
Termination penalties (if term is assumed not to be renewed)
Residual value guarantees, at the amount expected to be paid, if
any (lessee only); lessor does NOT include all types of them
– Exercise price of purchase option included in lease term
• Contingent rents based on performance or usage would be
excluded:
– Recognized as incurred/accrued
– Contingent rents must be truly variable to be excluded (aka not
“disguised min lease pmts”)
7
Lease Models
“Right to use”
leased property
Lessor
Models
Lessee
Models
Lease payments
Short term
leases - use op
lease method
Operating
Lease
Recognize
receivables and
residuals
Receivable
& Residual
approach
Derecognize
leased
property
Short term
leases - use op
lease method
Right of use
model*
Recognize
liability to
make lease
payments
*2 lease types: SLE (Type B) vs. I&A
(Type A) leases with different P&L cost
patterns
Recognize
“right of use”
asset
Most TRALA leases will be classified Type A for lessees & R&R for lessors
Lease Classification – ROU Model
Lessees:
•
•
2 new lessee types and approaches (except for short term leases)
Interest & Amortization (I&A) (Type A)
–
–
•
The lease is capitalized and the asset is amortized straight line and interest is imputed on the
liability.
The result is a front ended expense pattern.
Single Lease Expense (SLE) (Type B)
–
The lease asset and liability are capitalized, then adjusted each month With inoerest imputed on the
liability and plugged amortization on the asset to create a single (straight line) lease expense
Lessors:
•
Receivable & Residual (R&R) (Type A)
–
•
Record a PV receivable & residual asset, recognize finance income
Operating Lease (OL) (Type B)
–
Same as FAS 13 method
Lease Classification – ROU Model
Lessees:
•
•
Real estate and equipment leases are treated drastically differently.
For equipment leases – including most vehicle leases
–
–
–
•
For real estate leases
–
–
–
•
It is presumed that the lease is an I&A lease for lessees (bad news!) and an R&R lease for lessors
(good news!)
Unless the lease term is an insignificant portion of the economic life of the underlying asset or the
present value of the lease payments is insignificant relative to the fair value of the asset
These criteria are radically different for lessees than under existing FAS 13 GAAP so that most
equipment leases will have front ended lease costs
It is presumed the lease is a SLE lease for lessees and operating leases for lessors
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 asset.
These criteria are virtually the same as the line under existing FAS 13 GAAP so that most real
estate leases will have straight line rent expense
Net result: balance sheet amounts for equipment capital & operating leases
are jumbled & analysts won’t be able to adjust to get what they need!!!
Determining lease type
So, the million $$$ question – What is insignificant???
• FASB/IASB – no bright lines; joint webinar examples (lease term versus life)
Property
Commercial real estate (10 yr/40 Yr)
I&A
SLE
Commercial real estate (30 yr/40 Yr)
Other Than Property
Truck (4 Yr/10 Yr)
SLE
Vessel (5 Yr/40 Yr)
Vessel (20 Yr/40 Yr)
I&A
Airplane (8 Yr/25 Yr)
Car Fleet (3 Yr/6 Yr)
Re the PV test 10% has traditionally been the “insignificant” bright line
1111
Lessee Project Summary
Lessees:
• Capitalizes lease assets & liabilities via complex calculations &
adjustments ignoring lease economics
• Short term leases can use existing operating lease accounting (off
balance sheet)
• Estimate lease term & payments (include only bargain/compelling
renewals, bargain POs, “rate & index based” contingent rents & value
of residual guarantees) and capitalize at incremental borrowing rate
with continual adjustments to estimates
• Unbundle full service lease payment or else capitalize the
whole payment – lease portion should be capitalized, service
portion should be expensed as paid
• New classification tests – different for real estate and equipment
• Real estate lease get straight line rent expense (SLE or single lease
expense method)
• Equipment lease costs front ended – amortization & imputed interest
(I&A or interest and amortization method)
• Deferred tax accounting needed for all equipment leases
Front Ending of Lessee Lease Cost
Book Expense
Imputed Interest Expense + Depreciation
Str Line
Rent Exp
Imputed Int Exp
Depreciation
of ROU Asset
Mid Point
Lease Term
Expiry
What is the Project?
The Effect of Front Ending Lease Costs
Lease Term
First Year Increase in Lease
Cost – proposed rules vs.
current GAAP
3 Years
7%
5 Years
11%
7 Years
16%
10 Years
21%
20 Years
28%
What is SLE accounting?
Example
A company enters into a three-year lease for new office space and agrees to
pay the following: $10,000 in year 1, $12,000 in year 2 and $14,000 in year 3.
The present value of lease payments is $32,500 (using a discount rate of 5%).
Initial
Year 1
Year 2
Year 3
Income statement*:
$12,000
$12,000
$12,000
Lease expense
$12,000
$12,000
$12,000
$11,333
$–
Balance sheet
Right-of-use asset
$32,500
$22,125
Liability to make lease payments
$(32,500)
$(24,125) $(13,333)
$–
* Consists of
Initial
Year 1
Year 2
Year 3
Interest expense
$ 1,625
$ 1,208
$
667
Amortization expense
$10,375
$10,792
$11,333
Total
$12,000
$12,000
$12,000
15
What is I&A accounting?
Example
A company enters into a three-year lease for new $1,000 (list price) PC and
agrees to pay the following: $339 per year in arrears. The present value of
lease payments is $890 (using a discount rate of 7%).
Initial
Year 1
Year 2
Year 3
Interest expense
$ 62
$ 43
$
Amortization expense
$297
$296
$ 297
$359
$339
$319
Total
Income statement:
Lease expense
22
$1,017
Balance sheet
Right-of-use asset
$890
$593
$297
$0
Liability to make lease
pmts
$(890)
$(613)
$(317)
$0
Average rent paid
$339
$339
$339
% Lease exp B/(W) average
rent
(6%)
0
6%
$1,017
16
What is the Project?
TRALA Lessee Issues & Impact
Issue
Impact
New ROU asset & lease liability
capitalized – but not broken out
Same as calculation S&P and Fitch, less
than Moody’s capitalizes
Lease costs front ended for equipment
leases
Up to 16% higher than today in year of
transition, 3 to 8 years to turn around
Cash rent paid still the IRS tax deduction
New deferred tax assets on B/S
Bundled payment
Must break out service to avoid
capitalization
Lease cost more evident
Capitalize interim rents, CFO involved
Lease treated as capital item
No longer in operating budget, tougher
internal approval process
Simple short-term lease method
Good news for terms of 12 mos or less
with no option to renew
Compliance costs
Transition, ongoing process, complex
Lessee Analysis
TRALA Product Offerings
Product
Impact
Short Term Rental (1 yr or
less with no option to renew)
Exempt from new rules – election to continue to
use operating lease method (off balance sheet)
Full Service Lease
“Lease” portion of pmt capitalized - lessee must
break out the “service” portion or else the whole
payment amount is capitalized
Operating (Tax) Lease
Capitalized, but PV lower than equipment cost
Synthetic Lease/TRAC
Capitalize only contractual rents, compelling
renewal rents & estimated residual guarantee
payments – capitalizes far less than expected
Capital lease
Capitalized as under current rules
Impact by Lessee Type
Lessee type
Potential impact
Investment grade/large
companies
Some negative impact as leases often accounting
focused, have more sources of capital, more analytical
staff, loss of leveraged lease product increases lease
costs
Non-investment grade/small &
medium sized
Less impact as source of capital is prime reason for
leasing, fewer sources of capital, level payments & 100%
financing conserves cash, less concerned about balance
sheet optics, less staff to analyze lease and less analytical
Municipal/tax exempt
No change in municipal market as GASB, not FASB, issues
rules and operating leasing appears to be retained by
GASB, tax exempt leasing offers lowest cost, leasing
avoids issuing debt with all its constraints
What might the numbers look like?
Truck lease example:
Vehicle cost
Lease term
Basic rent payment
Lessee incremental borrowing rate
PV of basic rent
Percent capitalized vs. truck cost
$89,000.00
84 months
$1,101.51
7.00%
$72,983
82%
Capitalization Journal Entry:
Right to Use Leased Asset
$72,983
Capitalized Lease Obligation
$72,983
To record lease at inception (PV of lease rents)
Issues with bundled billed full service leases:
-Lessee must bifurcate service portion or capitalize whole payment
(results in well over 100% of vehicle cost capitalized!)
-Lessee will ask for break out of lease and service portions of payment
Implications for Lessees
• The PV of the lease rents will be recorded by the lessee as an asset and liability. As an
example, assume a 5 year $100,000 truck, where the PV rents are capitalized at
$89,517 or 89% of cost assuming a 8% discount rate (incremental borrowing rate).
• The P&L pattern will not represent the economic nature of a rental agreement as it will
be front-ended as level rent expense is replaced by imputed interest on the liability at
8% and straight line depreciation of the capitalized asset. For a 5 yr lease with monthly
rents of $1,815 the increase in first year expense is $2,333 or 11% higher than
straight line.
•
P&L Pattern
Current GAAP
Proposed GAAP
Difference
Difference
YR 1
21,781
24,114
(2,333)
-11%
YR 2
21,781
23,026
(1,245)
-6%
YR 3
21,781
21,863
(82)
-
YR 4
21,781
20,618
1,163
6%
YR 5
21,781
19,286
2,495
11%
TOTAL
108,905
108.905
0
0.0%
• The lessee will have to include contractual rents, bargain POs, bargain/compelling
renewals & estimated payments under residual guarantees. Non bargain renewals and
POs ignored in TRACs. Estimates to be reviewed & adjusted at each reporting date with
complex calculations & catch-up adjustments to be made.
• The P&L pattern will not match the IRS tax treatment triggering deferred tax
accounting.
Lessee TRAC Lease Example
Assumptions
Open end lease - level rent
vehicle cost
lease term in mos
rent pmt $/% of
cost
TRAC
delivery date 1/1
Lessee incr bor rate
TRAC = FMV
Options accounted for at fair value
Capitalized value under proposed rule
$20,000.00
36
Lessee Financials
Year end
Assets
inception
$11,701.84
Year end
1
$7,801.23
Liability
$11,701.84
$364.00
$10,000.00
1.82%
50%
7.50%
$11,701.84
% of cost
58.51%
2
$3,900.61
Year end
3
$0.00
$8,088.96
$4,195.61
($0.00)
depreciation
interest cost
total expenses
$3,900.61
$755.12
$4,655.74
$3,900.61
$474.64
$4,375.26
$3,900.61
$172.39
$4,073.01
$11,701.84
$1,402.16
$13,104.00
Annual rents
$4,368.00
$4,368.00
$4,368.00
$13,104.00
Rents paid vs. book expense
($287.74)
($7.26)
$294.99
$0.00
tax timing difference
Tax rate
deferred tax
amount
($287.74)
35.00%
($7.26)
35.00%
$294.99
35.00%
$0.00
($100.71)
($2.54)
$103.25
totals
Customer Talking Points
• New rules will capitalize lease payments on balance sheet
• Amount capitalized will be less than if you borrow to buy
• P&L cost will be front loaded for most vehicle leases
• Not logical - rent should be the expense
• The leasing industry & lessees will fight through comment letters
• % of front loading may not be material
• The front ending “turns around” so the reported cost is the same as
total rents
• Reasons for leasing remain
• Service/outsourcing/convenient
• Capitalized payments less than cost to buy
• Additional source of financing
• 100% financing/level payments
• Low financing costs/tax benefits/residual
• Right to return equipment/transfer residual risk
Business Reasons for Leasing
Reason for Leasing
Details
Status After Proposed New Rules
Raise Capital
Additional capital source, 100%
financing, fixed rate, level
payments, longer terms
Low payments/rate due to tax
benefits, residual & lessor low
cost of funds
Lessee can’t use tax benefits &
lease vs. buy shows lease option
has lowest after tax PV cost
Lessee has flexibility to return
asset
Still a major benefit versus a bank loan
especially for SME & non-investment grade
lessees with limited sources of capital
Still a benefit versus a bank loan
Still a benefit
Regulatory
Outsource servicing of the leased
assets.
Quick & easy financing process
often available at point-of-sale
Capital issues
Accounting
Off balance sheet
Low cost capital
Tax benefits
Manage
assets/residual risk
transfer
Service
Convenience
Still a benefit
Still a benefit
Still a benefit
Partial benefit if the PV < cost of the asset,
S/B true for hi residual assets w tax benefits
Partial benefit if the PV < cost of the asset,
S/B true for hi residual assets w tax benefits
What is the Project? - Lessor Details
• Lessor classification same as for lessees
• There are 2 methods as proposed
– The Receivable & Residual (R&R) method for
most vehicle leases (Type A leases)
– The Operating Lease method (for lease terms
of one year or less – without renewal options
& most RE leases(Type B leases))
• Lessors rebook virtually all leases except short
term leases on transition
Lessor accounting - receivable and residual
(most equipment leases)
•
•
Right-ofuse “sold”
•
Underlying
asset
•
•
Residual
asset
Record a lease receivable
Allocate a portion of the carrying
value of the underlying asset to
the right-of-use asset “sold”
Recognize “sales type” profit (or
loss) for the difference between
the PV of lease payments and
the carrying value allocated to
right-of-use asset “sold”
Record a residual asset as an
allocation of the carrying amount
of the underlying asset
“Sales type” profit associated
with the residual asset would be
deferred until the asset is
subsequently sold or re-leased
26
Illustrative example – Receivable & Residual
Lessor
Assumptions:
• A lessor manufactures a machine for $7,500 with a fair value of $10,000 = $2,500 gross profit
• Enters into a three-year lease with annual lease payments of $2,400 paid at end of each year
• Expected fair value of the residual asset at the end of the lease term is $4,770
• Interest rate implicit in the lease is approximately 7.87%
Commencement
Subsequent (year 1)
Lease receivable
$6,200
Gross residual
$3,800*
Cost of sales
$4,650
Deferred profit
Asset
Revenue
*Presented as net residual: $2,850
$950*
$7,500
$6,200
Cash
$2,400
Interest income – receivable
Lease receivable
Gross residual
Interest income – residual
$ 488
$1,912
$ 299
$ 299
Lease receivable (PV of annual lease payments of $2,400 at 7.87%) = $6,200 (rounded)
Carrying value of asset allocated to right-of-use asset “sold”: $7,500 x $6,200/$10,000 = $4,650
Profit recognized at lease commencement: $6,200 – $4,650 = $1,550 (or 62% of $2,500 gross profit)
Gross residual (PV of the estimated FV of residual asset of $4,770 at 7.87%) = $3,800 (rounded)
Carrying value of asset allocated to residual asset (net residual): $7,500 x $3,800/$10,000 = $2,850
Deferred profit: $3,800 – $2,850 = $950
Interest income on gross residual: $3,800 x 7.87% = $299 (rounded)
27
Illustrative example – Receivable & Residual
Proposed standard vs. current standard
Proposed standard
Deferred profit
Net residual
Profit
Profit
(sales-type lease)
$3,800
$ (950)
$2,850
$1,550
$2,500
$4,288
$4,099
$ (950)
$3,149
$ 787
$ 787
Year 2
$2,225
$4,422
$ (950)
$3,472
$ 660
$ 660
Year 3
$

$4,770
$ (950)
$3,820
$ 523
$ 523
$3,520
$4,470
Period
Receivable
Initial
$6,200
Year 1
Gross
residual
Current
standard
Total prior to sale of residual
28
Lessor presentation – Receivable & Residual
Balance sheet
•
•
Lease receivable and residual asset presented separately (summing to a
total “lease assets”) or shown as one “lease assets” with two amounts
disclosed in notes
Present gross residual and deferred profit together as a net residual asset
Income statement
•
•
•
•
Lease income and expense (e.g., revenue and cost of sales) in separate
line items or net in a single line item (lease income), depending upon
lessor’s business model
Income and expense from lease transactions presented separately in
income statement or disclosed in the notes
Accretion of residual asset in interest income
Amortization of initial direct costs as an offset to interest income
29
Lessor Issues & Impact
Issue
Impact
Short term leases exempt
Elect to keep using operating lease method
New Receivable & Residual
(R&R) method
Almost identical to current direct finance
method – earnings @ implicit rate
Sales-type gross profits
Recognized on all R&R leases but residual
portion deferred until residual resolved
Residual value insurance
Need for RVI?? No operating lease
accounting, may change residual to a
financial asset?
FAS 166 receivable sales
Receivables under former operating may be
financed as asset sales – works best for
synthetic leases (non-tax leases)
Transition
Virtually all leases rebooked, huge project,
revise systems
Lease Accounting Project
Possible Strategies/Tactics
•
•
•
•
•
Monitor the project – TRALA website, Leasing-101 website, IASB/FASB/ELFA
websites, articles
Comment to the FASB
Sales training
• Understand proposed rules
• Talking points
• Dealing with objections
Review products
– Accounting driven products will change – no longer 100% off balance sheet
– Customer will know PV of rents
– Focus on FMV tax leases, TRACs and synthetics with low PVs
– Interim rents & certain contingent rents will be capitalized
New products/offerings
– Use more TRAC-type structures
– Develop a “residual guarantee” product
– Provide accounting info to customers as a service
What is the Industry Doing?
• TRALA issued a comment letter to the FASB/IASB citing major
issues re the first ED:
– Estimating payments and adjusting continuously makes compliance
costly and burdensome
– Immaterial leases (cost =/< $250,000) and short term leases
should be exempt from capitalization
– Lease cost should be straight line
– Different leases should be accounted for differently
– Contingent rent and non-bargain renewals are not liabilities to be
capitalized
– Full service leases should not be unbundled – should be service
contracts
• Results:
They changed positions on renewals, mileage based
contingent rents, short term leases & revised lessor methods
What is the Industry Doing?
• TRALA & the NPTC issued an unsolicited comment
letter to the FASB/IASB citing major issues re their
final decisions:
– Classification tests S/B the same for equipment and real
estate leases & S/B based on FAS 13 & same as tax &
legal view
– Lease cost for former operating leases S/B straight line
to preserve capital
– Capitalized op lease liability should not be called “debt”
to avoid covenant breaches/preserve borrowing capacity
– Rules are too complex – most lease customers are small
companies
What is the Industry Doing?
•
•
•
•
TRALA, ELFA & worldwide leasing trade organizations jointly interacting with
the FASB & IASB providing industry input & expertise
Influencing the process to:
– Lessee accounting should reflect lease economics
– SL recognition of lease expense
– Operating lease liability not “debt”
– Avoid burdensome compliance for our lessee customers
– Save DFL, leveraged & sales-type lease accounting and get tax
effected DFL-like income recognition for true leases
PR campaign
– Engage lessees & manufacturers/lessors encouraging comment letters
– Meetings, articles & webcasts
Results:
– Got them to change position on renewals, mileage contingent
rents and short term leases
– Got them to reconsider lessor accounting model
WE NEED COMMENT LETTERS!!!
•
•
•
•
•
Read the Exposure Draft dated May 16, 2013
Comment on the Exposure Draft
Deadline for comments will be September 13, 2013
Get your customers and their parents to comment
There is an unofficial hierarchy of comment letters:
• User/lender comment letters carry the most weight
• Preparers are next in importance
• Lessor trade associations letters are viewed as self
serving – so trade associations alone cannot
change their views
Remaining Advocacy Issues – Lessee
Issue
Desired outcome
Basis for request
Lessee cost pattern for
equipment leases
•Maintain current straight
line average rent expense
for all operating leases as
they are executory contracts
•Reflects economics of an executory contract
•Asset = liability reflects value of the contract
•Matches revenue with costs in rent
reimbursement scenarios
•Matches tax and legal view
Lessee balance sheet
presentation
Lease liability re capitalized
operating leases should be
separately reported and not
labeled as debt
•Legally not the same as debt in bankruptcy
•Intent of debt limits is to limit more debt having
same legal claims on assets
•Avoids debt covenant limits
Sale leasebacks with any
PO not considered sales per
Rev Rec
A non bargain purchase
option should not negate
sale treatment
All the risks and most of the rewards in the
asset’s residual value have transferred to the
buyer indicating that a sale has taken place
Renewals that rise to a
significant economic
incentive are booked at
inception & costs are front
ended
Renewals should be booked
at commencement & the
cost pattern should be
straight line
•New leases are booked at commencement
•Front ending costs creates a saw toothed
pattern
•Costs of the renewal are accelerated into the
remaining term of the base lease
Ease requirements for
bundled lease payments
Estimates s/b allowed if no
rates available to lessee
•Elements of pricing proprietary
•Full capitalization onerous/incorrect
Remaining Lease Project Advocacy Issues - Lessor
Issue
Desired outcome
Basis for request
Gross profits deferred in
proportion to residual risk
RVI & RVGs to be
considered in the profit
calculation
A guarantee/insurance changes the residual’s
nature to a financial asset
Required symmetry in lease
classification with the lessee
tests
•Lessor business model
should be the basis for
lease classification
•Lessors in the “operating
lease” business should get
operating lease treatment as
real estate lessors do
•For financial lessors, the R&R method best
reflects the economics for their business
•For operating lessors, operating lease
accounting best reflects the economics of their
business
Tax benefits should be
factored into the revenue
recognition of leases
•The after tax yield on the
net cash invested should be
the pattern of revenue
recognized in R&R leases
•ITC should be a revenue
item
•Tax benefits are as much a part of revenue as
rents and residual sales
•Some transactions have significant tax benefits
& ignoring them distorts revenue recognition
Leveraged leases
•Grandfather existing deals
•Retain some form of
leveraged lease accounting
•Reflects economics of the transaction
•Avoids capital adequacy issues
•Reduces lease rates
Questions ?