BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Accounting for Leases
Now & Next
973.822.2220
Accounting for Leases (ASC 840 f/k/aSFAS 13)
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
•
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Learning Objectives:
To review recent developments in lease accounting and demonstrate how they have
affected accounting for leases as prescribed under SFAS 13, Accounting for
Leases.
Program Prerequisites: None
Program/Course Level: Overview
Program Content:
Lease accounting has been one of the most controversial accounting topics for
nearly two decades. This program will begin with a quick overview of the current
accounting for leases within ASC 840 (SFAS 13). The focus of the program will be
to address the current exposure draft on Leases, the significant rule changes, the
impact on both the lessee and lessor, impact on preexisting leases and comment
letters associated with this topic.
p
Advanced Preparation: None
Type of Delivery Method: Live & Group Internet Based
CPE Credits: 2
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BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
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BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Accounting for Leases
Developments in Lease Accounting
FASB Proposed ASU
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BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Accounting for Leases
Developments in Lease Accounting
FASB Proposed ASU
5
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
I. Overview
A lease is a contractual agreement between a lessor, who
conveys the right to use real or personal property (an
asset), and a lessee, who agrees to pay periodic rents over
a specified time.
Rental
Sale
Lessee
Operating Lease
Capital Lease
Lessor
Operating Lease
Sales Type
or
Direct Financing Type
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
II. Operating Leases
A. Definition
An operating lease includes a lessor, who collects
rent, and a lessee, who uses the leased asset and
pays periodic rent for such use. The lessee
merely uses the asset; there is no transfer of
ownership, or of any risk or benefit of ownership.
7
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
B. Accounting for Operating Leases
1. Lessee Accounting
a. Lease Rent Expense
The lessee records rent expense over the lease term,
usually on a straight-line basis unless other methods
are warranted (for example, lease expense can be tied
to sales, to the Consumer Price Index, or to the prime
interest rate).
DR
CR
Rent expense
Cash/rent payable
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$XXX
$XXX
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Accounting for Leases
BECKER GEARTY
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b.
Lease Bonus (Prepayment)
Lease bonus (prepayment) for future expenses should be classified as an asset
(deferred charge) and amortized using the straight-line method over the life of the
lease.
c.
Leasehold Improvements
A leasehold
l
h ld iimprovementt iis one th
thatt iis permanently
tl affixed
ffi d tto th
the property
t and
d
reverts back to the lessor at the termination of the lease. In general, if the property
is not moveable from the premises by the tenant, it is a leasehold improvement. Air
conditioning ducts would be considered a leasehold improvement, while a painting
hanging on a wall would not.
1) Capitalize Leasehold Improvements
The value of leasehold improvements should be capitalized and added to the property,
plant, and equipment section or the intangible assets section of the balance sheet.
2) Depreciation—Useful Life or Lease Term
Leasehold improvements should be depreciated (amortized) over the lesser of:
a)
Lease life
b)
Asset/improvement life
d.
Rent Kicker
A premium rent payment required for specific events.
e.
Refundable Security Deposit
Is reported as an asset until refunded by the lessor.
1) Period expense
9
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
f.
Free or Reduced Rent Consideration
If consideration (free rental months or reduced rental charge at
beginning) is part of the package, lessee must take total rent expense
to be paid for the entire lease term and divide it evenly over each
period (matching principle).
Rental-Agreement
5 years (60 months) @
$1,000
*First 6 months are free
Net cost for five years
EX
XAMPLE
Total months rented
Monthly rental expense
$60,000
<6,000>
$54,000
÷ 60 mo.
$
900
First 6 months ( Mo. 1 – 6)
DR
CR
Rent expense
$900
Rent payable
$900
Next 54 months (Mo. 7 – 60)
DR
Rent expense
DR
Accrued rent payable
CR
Cash/rent payable
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$900
100
$1,000
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
C.
Leasing Issues
1.
2.
Background and evolution
a
a.
Restatements
b.
SEC Staff Letter
Primary issues
a.
Amortization of leasehold improvements
b.
Rent holidays
c.
Lease incentives
d.
Disclosures
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Issue 1: Amortization of Leasehold Improvements
‰
‰
‰
Amortized by lessee over the shorter of:
ƒ
Their economic lives
ƒ
Lease term (as defined in ASC 840, f/k/a SFAS 13)
Amortization of LHIs over a term that includes renewals is appropriate only when renewals have
been determined to be "reasonably assured"
A lease that is cancelable……
ƒ
only upon the occurrence of some remote contingency,
ƒ
only with the permission of the lessor,
ƒ
only if the lessee enters into a new lease with the same lessor, or
ƒ
only if the lessee incurs a penalty in such amount that continuation of the lease appears, at
inception, reasonably assured
... is considered non-cancelable
KEY POINT
Leasehold improvements cause renewal option to be "reasonably assured: when:
1.
LHIs are expected to have significant value at end of initial period such that lessee is
not willing to abandon these assets (i.e. effectively incur a penalty)
2.
Renewal option reasonably assured of exercise
3.
Add the renewal period to the initial term to determine appropriate term for
accounting purposes
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Issue 2: Rent Holidays
•
Apply ASC 840
840-20-25;
20 25; f/k/a/ FASB Technical Bulletin 85-3,
85 3,
"Accounting for Operating Leases with Scheduled Rent
Increases"
•
Operating leases with rent holidays should be recognized:
1.
On a straight-line basis
2.
Over the lease term
3.
Including the rent holiday period: lease term for accounting purposes
includes all periods lessee has access to and control over leased space
space.
• Straight-line applies unless another systematic or rational
allocation is more representative of the time pattern in which
the leased property is physically employed.
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Issue 3: Lease Incentives
•
Landlord incentives for Leasehold Improvements:
1.
Acquisition of LHI is capitalized asset
2.
Incentive received recorded as a deferred rent by lessee
3.
Amortize incentive as reduction to lease expense over the lease
term
4.
Cash Flow Statement
a.
Acquisition of the leasehold improvement in "investing
activities"
b.
Proceeds of incentive as "operating activities"
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Issue 4: Disclosures
Amortization Period
For LHIs
Material Lease
Agreements
Disclosures:
Accounting Policies
for Leases
Footnotes, MD&A Critical
Accounting Policies
Basis for
Contingent Rents
Provisions of Material
Leases
original term, renewal
periods, reasonably assured
rent escalations, rent
holidays, contingent rent,
rent concessions, LHI
incentives and other unusual
provisions
15
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
2.
Lessor Accounting
a. Fixed Asset
The cost of the property is included in the
lessor's property, plant and equipment.
1) Depreciation—over the asset's useful life
b. Rental Income
Rental income is reported on either the
straight-line or other systematic method
method.
DR
CR
Cash/rent receivable
Rental income
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$XXX
$XXX
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
c.
DR
Security Deposits
Security deposits required by the lease may be either
refundable or nonrefundable:
1)
Nonrefundable—deferred by the lessor
(unearned revenue) and capitalized by the
lessee (prepaid rent expense) until the lessor
considers the deposit earned.
2)
Refundable—treat as a receivable by the lessee
and a liability by the lessor until the deposit is
refunded
f d d tto the
th lessee.
l
Cash
CR
$XXX
Refundable deposit
$XXX
17
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
KEY POINT
• Do not recognize security deposits as revenue in advance of their being earned
(violation of the Rule of Conservatism).
• Remember, revenue is only recognized when the earning process is complete; we
never anticipate revenue.
d.
e.
Temporary Difference
1)
GAAP Rule – report prepaid rental income when
earned
2)
Tax Rule – report prepaid rental income when
received
Lease Bonus
The lease bonus is deferred (unearned income) and
amortized (into income) over the life of the lease.
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
f.
Free or Reduced Rent Consideration
If consideration (free rental months or reduced rental charge at
beginning) is part of package, lessor must take total rental income to
be paid for the entire lease term and divide it evenly over each period
(matching principle/revenue recognition principle).
Rental-Agreement
5 years (60 months) @ $1,000
$60,000
EXAM
MPLE
*First 6 months are free
<6,000>
Net rental income for five years
$54,000
Total months rented
÷ 60 mo.
Monthly rental income
$
900
First 6 months ( Mo
Mo. 1 – 6)
DR
Accrued rent receivable
CR
$900
Accrued rental income
$900
Next 54 months (Mo. 7 – 60)
DR
Cash
$1,000
CR
Rental income
$900
CR
Rent receivable
100
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
III.
Capital Lease
A capital lease transfers substantially all of the benefits and
risks inherent in ownership
p of p
property
p y to the lessee.
i.
This is an accounting transaction, which is, in substance, an
installment purchase in the form of a leasing arrangement.
ii.
The lessee accounts for this type of lease as the acquisition of
both an asset (leased asset under capital lease) and a related
liability (obligation under capital lease).
iii.
The lessor accounts for such a lease as a sales-type or a direct
financing lease. A sales-type lease results in a dealer's or
manufacturer's profit or loss to the lessor. A direct financing
lease does not result in a dealer's or manufacturer's profit or loss.
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Accounting for Leases
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CONTINUING PROFESSIONAL EDUCATION
A. Lessee Capital Lease Criteria
1. Must meet just one condition to capitalize.
DR
Fi d asset—leased
Fixed
t l
d property
t
CR
$XXX
Liability—obligation under capital lease
$XXX
Ownership transfers at end of lease (upon final payment or required buyout)
Written option for bargain purchase
Ninety (90%) percent of leased property F.V. <= P.V. of lease payments
Seventy-five
y
((75%)) percent
p
of asset economic life is beingg committed in lease term
2. Criteria (N) and (S) cannot be used for a lease that begins
within the last 25% of the original estimated economic life of
the leased property.
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
EXAMPLE
Equipment FV is $3,500, lease payments are $1,000 per year, on 12-31 lease term is four years,
assett life
lif iis tten years.
Incremental borrowing rate is 10%
No ownership
No written bargain
FV
P.V. Cost
1
2
3
4
$1,000
$1,000
$1,000
$1,000
$3,500
x 90%
$3,150
$ 910
830
750
680
$3,170
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
B. Lessor: Sales-Type/Direct Financing Type Criteria
1. If a lease, at inception, meets all three of the
following conditions,
conditions it shall be classified by the
lessor as a sales-type or direct financing lease,
whichever is appropriate.
Lessee "owns" the leased property (meets any one of the four lessee's criteria)
Uncertainties do not exist regarding any unreimburseable costs to be incurred by
the lessor.
Collectibility of the lease payments is reasonably predictable.
23
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
IV. Lessee (Capital Lease) Accounting
A.
DR
CR
Calculation of Leased Asset and Liability Amounts
The lessee treats the capital lease as if an asset were being
purchased over time; that is, it is a financing transaction in
which an asset is acquired and a corresponding obligation
(liability) is created.
Fixed asset—leased property
$XXX
Liability—obligation under capital lease
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$XXX
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
1.
Recording the Lease
a. Capitalized Amount
Th llessee records
The
d th
the lease
l
as an assett and
d a liability
li bilit
at the lower (lesser) of:
1) Fair value of the asset at the inception of the lease,
or
2) Cost = present value of the minimum lease
payments.
25
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
a)
b)
Includes (all payments that the lessee is obligated to make):
1)
Required Payments
2)
Bargain Purchase Option
When the lease contains a bargain purchase option
option, the lease
obligation includes the present value of the payment required to
exercise the bargain purchase option in addition to the present
value of the minimum lease payments.
3)
Guaranteed Residual Value
The guaranteed residual value is the amount guaranteed by the
lessee to the lessor for the estimated residual value of the asset
at the end of the lease term.
Exclude:
1)
Executory Costs
I
Insurance,
maintenance,
i t
and
d ttaxes can be
b paid
id b
by th
the lessor
l
or
lessee. If the lessor pays them, a portion of each lease
payment representing executory costs is excluded from the
calculation of minimum lease payments. If the lessee pays
these costs directly, they are not included in the minimum lease
payments.
2)
Optional Buyout (not required and not a bargain)
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
KEY POINT
Periodic payment
•Beginning = PV of an annuity due
•Ending = PV of an annuity (in arrears/ordinary)
Bargain
OR
Guaranteed residual
•PV of $1
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
b. Interest Rate
The lessee uses the incremental borrowing rate,
d t
determined
i d as th
the llower (l
(lesser)) of:
f
1) Rate implicit in the lease (if known)
2) Rate available in market to lessee (not prime)
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
c. Summary
Capitalized Cost (remember, lower of this cost or market):
O wnership
=
PV of payments and required buyout—(if any)
W ritten
=
PV of payments and bargain buyout
N inety % FV
=
PV of payments (not option buyout)
S eventy five % life
=
PV of payments (not option buyout)
29
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
B.
Term to Use in Computing Depreciation of the Asset
1. Formula for Depreciation
Capitalized lease assets
< Salvage value>
Depreciable Basis
÷ Periods of benefit
Depreciation Expense (per period)
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
2. Period of Benefit (Depreciable Life)
a. Ownership Transfer and Written Bargain
1) Estimated economic life of the asset if the lessee
takes ownership of the leased asset by the end of
the lease or if there is a bargain purchase option as
part of the agreement. The asset is depreciated in
a manner consistent with the lessee's normal
policies.
b. Ninety % FV and Seventy-five % Life
1) The lessee uses the lease term if the lessee does
not take ownership of the asset by the end of the
lease or if there is not a bargain purchase option.
31
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
3. Summary
Depreciation Rules: (Capitalized "lease"
lease asset—salvage
asset salvage value):
Ownership
=
Depreciate over asset life (legal form)
Written
Ninety % FV
Seventy five % life
=
Depreciate over asset life (legal form)
=
Depreciate over lease life (substance over form)
=
Depreciate over lease life (substance over form)
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
E.
Summary of Lessee Capitalization Rules
1. Capitalize
As PP&E on the balance sheet, the leased asset at the lower LESSER of:
a. Cost
PV of future lease payments
Include: Guaranteed Residual Value by Lessee, Bargain Purchase Option (if applicable)
Exclude: "Executory Cost" = Insurance, Taxes, and Repair & Maintenance
1)
Discount Rate: Incremental borrowing rate is the lower (LESSER) of:
a) Rate implicit in the lease (if known)
b) Rate available in market to lessee (not prime)
b. Fair Value
Capitalize
Depr. Life
Ownership
=
PV of payments and required buyout
Asset life
Written
=
PV of payments and bargain buyout
Asset life
Ninety % FV
=
PV of payments (ignore option)
Lease life
Seventy-five % life
=
PV of payments (ignore option)
Lease life
33
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
KEY POINT
If a lease meets more than one of the criteria, then the order of
priority for applying the rules is the exact way they are spelled:
O–W–N–S
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
V. Lessor Accounting
35
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
A. Recording a Sales-Type Lease
g are the terms which are important to
Following
know for sales-type leases:
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
1.
Gross Investment (lease receivable)
The minimum lease payments plus any unguaranteed
g to the benefit of the lessor. This is
residual value accruing
recorded as Lease Payments Receivable on the lessor's
books.
Lease payment
+ Unguaranteed residual value
Gross investment
37
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
2.
Net Investment
This is computed as the sum of the present value of the
payments
y
and the p
present value of any
y
minimum lease p
unguaranteed residual value accruing to the benefit of the
lessor, using the interest rate implicit in the lease.
Lease payments
+ Unguaranteed residual value
Gross investment
x
PV
Net investment
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
3.
Unearned Interest Revenue (Contra-Lease Receivable)
The gross investment less unearned interest revenue equals
net investment. This is amortized over the life of the lease
by the effective interest method and is included in the
balance sheet as a deduction from the gross investment to
report the net investment.
Gross investment
< Net investment >
Unearned interest revenue
39
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
4.
Cost of Goods Sold
The cost of the leased asset plus any initial direct costs,
g fees or commissions to the lessor,, minus the
such as legal
present value of any unguaranteed residual value accruing
to the lessor's benefit. This is charged against income in the
period in which the corresponding sale is recorded.
Cost of Asset
< PV Unguaranteed Residual >
Cost of Goods Sold
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Accounting for Leases
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5.
Sales Revenue
The present value of the minimum lease payments is
p
recorded as sales revenue. This does include the present
value of any guaranteed residual value but does not include
the present value of any unguaranteed residual value.
41
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
EXAMPLE
Recording a SaleSale-Type Lease with Unguaranteed Residual Value (Lessor
(Lessor))
Assume that a lease with a tenten-year term requires rental payments of $5,000 on January 1 of
each year. The lessor's cost for the leased asset is $35,000. The estimated fair value at the
end of the lease (unguaranteed residual value) is $4,000, and the lessor retains ownership at
the end of the lease. The implicit interest rate is 10 percent (P.V. of annuity due is 6.759 and
PV of $1 is .386). Compute the information necessary to record this sales
sales--type lease.
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
EXAMPLE (continued)
1.
Gross investment
= Minimum lease payments + Unguaranteed residual value
= ($5,000 x 10 yrs) + $4,000
= $54,000
43
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
EXAMPLE (continued)
2.
Net investment
= Lease payments x PV of annuity due of $1, 10 periods, 10%
+ Unguaranteed residual value x PV of $1, 10 periods, 10%
= ($5,000 x 6.759) + ($4,000 x .386)
= $35,339
(The present value of the minimum lease payments, but not the unguaranteed residual value, is
recorded as sales, $5,000 x 6.759 = $33,795)
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Accounting for Leases
BECKER GEARTY
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EXAMPLE (continued)
3.
Unearned interest revenue = Gross investment – Net investment
= $54,000 – $35,339
= $18,661
45
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
EXAMPLE (continued)
4.
Cost of goods sold
= Lessor’s cost of leased asset + Initial direct costs
– PV of unguaranteed residual value
= $35,000 + 0 – ($4,000 x PV of $1, 10 periods, 10%)
= $35,000 – (4,000 x .386)
= $33,456
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Accounting for Leases
BECKER GEARTY
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EXAMPLE (continued)
5.
Present value of lease
payments (sale)
= $5,000 x 6.759 = $33,795
47
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
EXAMPLE (continued)
Journal Entry: To record this sales-type lease
DR
DR
CR
CR
CR
Lease payments receivable
Cost of goods sold
Sales
Equipment
Unearned interest revenue (contra-lease receivable)
$54,000
33,456
$33,795
35,000
18,661
Note: The lessor’s profit on sale is $33,795 – $33,456 = $339, which is recognized at the lease’s
i
inception.
ti
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48
24
Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
B.
Recording a Direct Financing
Since no manufacturer's or dealer's profit is realized in a
g lease,, the fair value of the leased property
p p y
direct financing
equals the cost or carrying value at the inception of the
lease. The information necessary to record this type of
lease is:
49
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
1. Gross Investment (Lease Receivable)
Gross investment equals the minimum lease payments
plus the unguaranteed
p
g
residual value and is recorded
as Lease Payments Receivable.
Lease payments
+ Unguaranteed residual value
Gross investment
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50
25
Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
2. Net Investment
Net investment equals the gross investment plus any
unamortized initial direct costs less the unearned
income. The initial direct costs are amortized over the
lease term by the effective interest method.
Lease receivable
+ Unguaranteed residual
Gross investment
x
PV
Net investment
51
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
3. Unearned Interest Revenue
This is the gross investment less the cost of the leased
property
p
p yp
plus any
y initial direct costs. It is amortized over
the lease term by the effective interest method.
Gross investment
< Net investment >
Unearned interest revenue
Journal Entry: To record a direct financing lease
DR
Lease receivable (gross investment)
$54,000
CR
Unearned interest revenue (contra-lease receivable
$18,661
CR
Asset (at cost or FMV) (Cost + nonrecorded profit)
35,339
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52
26
Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
VI. Sale-Leaseback
53
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
A.
Introduction
In a sale-leaseback transaction, the owner of a property
(seller-lessee) sells the property and simultaneously leases
it back from the purchaser-lessor. Usually there is no visible
interruption in the use of the property. Sale-leaseback
transactions are treated as single financing transactions
where, in general, any profit or loss is deferred and
amortized. In general, two questions are involved in
determining the treatment of any profits:
1. Is the lease a capital or operating lease? And
2. What portion of the rights to the leaseback property are
retained?
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27
Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
B. Terminology
1. Selling Price
S lli price
Selling
i iis th
the negotiated
ti t d price
i iin th
the salel
leaseback agreement. It may be less than, equal to, or
greater than the fair value of the property, depending on
the negotiated terms of the sale-leaseback.
2. Profit or Loss on Sale
Profit or loss on the sale is the amount which would
have been recognized by the seller-lessee assuming
there was no leaseback. It is calculated by subtracting
book value from fair value (sale price).
55
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
3. Excess Profit on Sale-Leaseback
a. Operating Lease Excess Profit
The amount of profit on the sale which
exceeds the present value of the minimum
lease payments.
Sale price
< Asset NBV>
T t ti gain
Tentative
i
< PV min. lease payments>
Excess gain
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56
28
Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
b. Capital Lease Excess Profit
The amount of profit on sale that exceeds the
recorded amount of the asset. Note that this
amount will be the same as in an operating lease
unless the leaseback asset is recorded at the
lower fair value.
The recorded amount of the leaseback asset is
the lesser of
i.
The fair value of the leased property, or
ii. The present value of the minimum lease
payments.
57
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
4. Rights to Remaining Use of Property Retained by SellerLessee
The rights to the remaining use of the property are determined by the present
value of rent p
payments
y
p
paid by
y the seller-lessee. The seller-lessee's rights
g
may be categorized as follows:
a.
"Substantially All" Rights Retained (Greater than 90%)
The present value of the rent payments is equal to or greater than 90% of the
fair value of the property. These leases are usually accounted for as capital
leases.
b.
Rights Retained Are Less Than "Substantially All" but Greater than
"Minor" (Between 90% - 10%)
The present value of the rent payments is less than 90% of the fair value, but
greater than 10% of the fair value of property at the lease inception. These
leases are accounted for as either capital or operating leases, depending on
the criteria
criteria.
c.
"Minor" Portion of Rights Retained by Seller-Lessee (Less than 10%)
The present value of the rent payments is 10% or less of the fair value of the
property at lease inception or the lease (back) period is 10% or less of the
asset's remaining life. These leases are usually accounted for as operating
leases.
Note: To determine whether any sales-leaseback transaction should be
accounted for as operating or capital, use the "OWNS" test.
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58
29
Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Sale-Leaseback: Summary
Gain
Major
90% or More
Middle
90%—10%
Defer All
Defer
(up to PV of leaseback)
(Amortize over leaseback)
Loss (NBV > FMV)
(real economic losses)
Other Losses
(artificial loss)
Recognize
Immediately
Minor
10% or Less
(Life or Sales Price)
No Deferral
(Amortize over leaseback)
Recognize
Immediately
Recognize
Immediately
Defer All
Defer All
(Amortize over leaseback)
(Amortize over leaseback)
Recognize
Immediately
59
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Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
EXAMPLE
Leaseback—Less Than "Substantially All" but More Than "Minor"
On January 1, Year 1, Carlson Company sold an airplane with an estimated useful life of ten years.
Carlson simultaneously leased back the airplane for three years. The lease is classified as an
operating lease. Applicable data follow:
Sale price, fair value
Book value of airplane
Monthly rental
Present value of lease rentals
$500,000
100,000
5,100
153,000
Calculate the amount of Carlson’s profit recognized on January 1, Year 1, and rent expense on
December 31, Year 1.
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
60
30
Accounting for Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
EXAMPLE (continued)
The present value of lease rentals exceeds 10% of the fair value ($50,000) but is less than 90%
of the fair market value ($450,000).
($450 000) Therefore
Therefore, the amount of profit recognized is the amount in excess
of the present value of the minimum lease payments. The calculation follows:
Sale price
Less book value
Total profit
Less present value of lease payments
(deferred amount)
Profit recognized at lease inception 1/1/Yr 1
(excess profit on sale leaseback)
$500,000
(100,000)
400,000
(153,000)
$247,000
Carlson’s rent expense for the year is calculated as follows:
Annual rent payments ($5,100 x 12 months)
Less one year recognition of deferred profit
($153,000 ÷ 3 years)
Rent expense 12/31/Yr 1
$ 61,200
(51,000)
$ 10,200
61
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Accounting for Leases
Developments in Lease Accounting
FASB Proposed ASU
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
62
31
SEC Staff Report to Congress
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
I. July 2005 – SEC Staff Issued Report to Congress
A. Required under §401 (c) of Sarbanes-Oxley Act
B. The extent of Off-Balance Sheet Arrangements
C. Whether current financial statements
transparently reflect the economics of offbalance sheet arrangements
D. Among many topics, Lease Accounting is
discussed
63
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Improving Financial Transparency
Objectives-Oriented Standards
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
II. SEC recommends: Accounting standards that are
principle-based or "objectives-oriented":
ƒ
ƒ
ƒ
ƒ
ƒ
Clearly state the accounting objective
Minimize the use of exceptions in a standard
Avoid use of percentage tests ("bright lines") to evade intent
Based on an approved and consistently applied conceptual
framework
Provide sufficient detail and structure to operationalize and
consistently apply
III. Rules-based standards:
ƒ
"further a need and demand for voluminously detailed
implementation guidance creating complexity and uncertainty in
the standard."
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
64
32
SEC Standard Setting
Recommendations—Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
IV. Reconsider Accounting for Leases
A. Repeatedly identified as an area to be reexamined by the
FASB.
FASB
B. Current "all or nothing" approach
ƒ
not designed to reflect the wide variety of lease structures.
C. Transparency and consistency in reporting is not achieved.
D. A project on lease accounting would be consistent with several
of the key initiatives identified in achieving transparency in
reporting
reporting.
65
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SEC Standard Setting
Recommendations—Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
• Reconsider Accounting for Leases (continued)
E. Currently uses "bright-lines"
1. Increases potential for similar arrangements to be portrayed
differently
F. “Bright-line” tests facilitate structuring leases by form over
substance
1. Seek desired accounting treatment vs. principle-based
approach
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66
33
SEC Standard Setting
Recommendations—Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
V. The lease project is complex and controversial
VI Leases have many different terms including:
VI.
ƒ
contingent rents
ƒ
optional extensions
ƒ
penalty clauses
ƒ
purchase options
67
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Accounting for Leases
Developments in Lease Accounting
FASB Proposed ASU
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
68
34
Proposed FASB ASU on Leases
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Accounting for Leases
Developments in Lease
Accounting
FASB Proposed ASU
General Provisions of Lease
Accounting
Lessee Accounting
Lessor Accounting
Other Lease Accounting Topics
Effects on Financial Reporting
Transition and Effective Date
69
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
Leases
General Provisions
I.
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Corporate Behavior – Why Enter into a Lease?
A. Avoid large initial cash outlays
B. Features and options offered by lessor
C. Financial flexibility
D. Off-balance sheet financing
E. Tax Advantages of capital lease – deductions for:
1. Depreciation
2. Interest Expense
3. Synthetic Leases
p company
p y may
y lack credit to borrow from bank
F. Start-up
G. Restaurants and Retailers:
1. No need for lease vs. buy decision (shopping malls)
2. Embedded in business model
3. Prime Location
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70
35
Leases – 2010 Exposure Draft
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
II.
Leases – 2010 Exposure Draft
A.
On August 17, 2010, the ISAB and the FASB issued an exposure
draft on Leases that p
proposes
p
that a new standard on lease
accounting for lessees and that lessors would replace IAS 17 Leases,
IFRC 4 Determining whether an arrangement contains a Lease, SIC15 Operating Leases – Incentives, and SIC-27 Evaluating the
Substance of Transactions Involving the Legal Form of a Lease.
Source: Aug. 2010 Exposure Draft
71
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Leases
General Provision
III.
CONTINUING PROFESSIONAL EDUCATION
Definition
A.
IV.
BECKER GEARTY
Lease – a contract in which the right to use a specified asset is conveyed, for a period of time,
in exchange for consideration.
Scope
A.
The proposed standard will apply to all leases including subleases of right-to-use assets. Some
arrangements that are specifically stated to not be within the scope of the exposure draft are:
1.
Leases of intangible assets
2.
Leases to explore for or use minerals, oil, natural gas, and other nonregenerative
resources;
3.
Leases of biological assets; and
4.
Leases that meet the definition of onerous contracts prior to the date of the
commencement of the lease.
5.
Contracts that represent the purchase or sale of the underlying asset would be excluded
from the scope. A contract constitutes a purchase or a sale if, at the end of the contract,
the contract transfers both of the following:
a.
Control of the underlying asset.
b.
All but a trivial amount of the risk and benefits associated with the underlying asset.
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36
Leases
General Provision
IV.
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Scope
B.
C.
Includes:
1.
Combined services and lease contracts (bifurcate lease)
2
2.
Short term leases
3.
Sale-leasebacks
4.
Subleases
5.
Leveraged leases (tentatively added at the July 13, 2011 meeting)
Excludes immaterial items.
1.
If material in the aggregate, consider a policy similar to PP&E capitalization policy.
72
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
Leases – 2010 Exposure Draft
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
•
.
KEY POINT
DEFINITION OF A LEASE AS UPDATED BY THE BOARDS ON APRIL 12
12, 2011
1. An entity would determine whether a contract contains a lease by assessing whether:
a. The fulfillment of the contract depends on the use of a specified asset; and
b. The contract conveys the right to control the use of a specified asset for a period of time.
2. A contract would convey that right to control the use if the customer has the ability to direct the use,
and receive the benefit from use, of a specified asset throughout the lease term. Guidance on
separating the use of a specified asset from other services should be aligned with the boards’ tentative
decisions in March 2011 relating to the separation of lease and non-lease components.
3. A “specified asset” refers to an asset that is explicitly or implicitly identifiable.
4. A physically distinct portion of a larger asset of which a customer has exclusive use is a specified
asset. A capacity portion of a larger asset that is not physically distinct (for example, a capacity portion
of a pipeline) is not a specified asset.
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
74lese
37
Leases – 2010 Exposure Draft
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
•
.
KEY POINT
T i pending
Topics
di B
Board
dd
decision
i i on whether
h th they
th will
ill be
b included
i l d d iin scope:
1. Leases of internal-use software in accordance with Subtopic 350-40,
Intangibles–Goodwill and Other Internal-Use Software, of the FASB Accounting
Standards Codification®.
2. Leases of inventory.
74
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
Leases
General Provision
V.
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Types of Leases
A. At the Feb 17th meeting the boards tentatively decided to identify a
principle for identifying two types of leases for both lessees and
lessors with different profit and loss effects
lessors,
effects, as follows:
1. A finance lease with a profit or loss recognition pattern
consistent with the proposals in the exposure draft .
2. An other-than-finance lease with a profit or loss recognition
pattern consistent with an operating lease under existing
IFRSs/U.S. GAAP.
B. The boards tentatively decided to establish indicators to distinguish
a finance lease from an other-than-finance lease
C. The boards asked the staff to use these tentative decisions to
perform targeted outreach to determine if stakeholders’ concerns
about the profit and loss recognition pattern proposed in the
exposure draft would be addressed.
D. To date no subsequent decisions on this topic have been noted.
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38
Leases
General Provision
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
KEY POINT
Ownership transfers at end of lease (upon final payment or required buyout)
Written option for bargain purchase
Ninety (90%) percent of leased property F.V. <= P.V. of lease payments
Seventy-five (75%) percent of asset economic life is being committed in lease term
Operating Leases
73
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
Leases – 2010 Exposure Draft
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
•
Note: A contract would normally meet both of these criteria when it transfers
title of the underlying asset automatically at the end of the contract or
includes a bargain purchase option in which it is reasonably certain, at the
inception of the lease, that the lessee will exercise the option. But, all facts
and circumstances should be considered, not just how the transaction is
described in the contract.
KEY POINT
• The determination about whether a contract is a purchase or sale is made at
the time of inception and is not subsequently reassessed.
• Transfer
T
f off the
th title
titl off th
the assett alone
l
is
i insufficient
i
ffi i t for
f an entity
tit to
t decide
d id
that the transaction should be treated as a purchase or sale. For purchase
or sale treatment, all but a trivial amount of the risks and benefits must also
be transferred to the lessee.
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39
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Accounting for Leases
Developments in Lease
Accounting
General Provisions of Lease
Accounting
FASB Proposed ASU
Lessee Accounting
Lessor Accounting
Other Lease Accounting Topics
Effects on Financial Reporting
Transition and Effective Date
75
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
Lessee Accounting - General
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
General
•
•
•
A lessee
lessee’s
s rights and obligations
under all leases, existing and
new, would be recognized on
the balance sheet.
Removes the concept of capital
leases and operating lease
classifications.
Straight-line rent expense will be
replaced with amortization of the
right-of-use asset and interest
expense on the lease obligation
L
Lessee
R
Recognizes
i
on
Balance Sheet
“Right--of
“Right
of-use” Asset
Amortization
Expense
Liability to
make Lease
Payments
Interest Expense
Income Statement
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
76
40
Lessee Accounting – Initial Measurement
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
I.
Initial Measurement
A.
B.
C.
D.
Initially recognize asset and liability at present value of lease
payments
y
to be made.
The right-of-use asset is measured at the amount of the lease
obligations plus any initial direct costs incurred.
1. Initial direct costs: Incremental costs directly attributable to
negotiating and arranging the lease that would not have been
incurred had the lease transaction not been made (commissions,
legal fees) .
Present value uses the rate charged by lessor if available or lessee’s
incremental borrowing rate.
It also includes:
1. Options (renewal and termination) in lease term
2. Contingent rentals, residual value guarantees and termination
payments
77
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Lessee Accounting – Initial Measurement
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
E.
Measurement Date
1. The initial measurement of the lease asset and liability as well
as the date to determine the discount rate is to be the
commencement date of the lease rather than the inception date.
a) Inception of the lease is the earlier of the date of the lease
agreement and the date of commitment by the parties to
the principal provisions of the lease.
b) Commencement of the lease term is the date from which
the lessee is entitled to exercise its right to use the leased
asset.
2 The lease standard will also include guidance regarding:
2.
a) The treatment of costs incurred between the inception
and commencement dates.
b) Lease payments made prior to the commencement date.
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
77
41
Lessee Accounting – Lease Term
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
II.
Lease Term
A.
B.
C.
The lease term is now the same for lessee and lessor. It is defined as
“the non-cancellable period for which the lessee has contracted with
the lessor to lease the underlying asset,
asset together with any options to
extend or terminate the lease when there is a significant economic
incentive for an entity to exercise an option to extend the lease, or for
an entity not to exercise an option to terminate the lease Lessees
would be required to estimate the ultimate expected lease term and
periodically reassess such estimate.”
The boards are to publish indicators of what defines a clear economic
incentive.
p
“only
y when there is a
The lease term will be reassessed byy both parties
significant change in relevant factors such that the lessee would then
either have, or no longer have, a significant economic incentive to
exercise any options to extend or terminate the lease.”
78
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
Lessee Accounting – Lease Payments
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
III. Lease Payments
A. Concept of “minimum lease payments” is gone.
B “L
B.
“Lease payments”
t ” will
ill include
i l d contractual
t t l payments
t plus
l estimated
ti t d
contingent rentals.
1.
Percentage rent.
2.
Payments which depend on an index or rate – updated at the
July 20 meeting.
a.
Initial measurement at date of commencement of lease.
b
b.
Reassess at the rate in effect at the end of each reporting
period.
c.
Reflect any adjustment in the income statement if it applies
to the current period or to the value of the right-to-use
asset if they relate to a future period.
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85
42
Lessee Accounting – Lease Payments
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
IV. Lease Payments
3.
Termination penalties – should be consistent with the
accounting for options to extend or terminate a lease
lease.
4.
Guaranteed residual values – except for amount guaranteed
by unrelated third parties.
85
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Lessee Accounting – Lease Payments
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
C. Contingent Rentals and Residual Value Guarantees
1.
The exposure draft provides that contingent rentals and
es dua value
a ue gua
guarantees
a tees must
ust be est
estimated
ated a
and
d accou
accounted
ted
residual
for using an expected outcome approach, based on a
probability-weighted average for a reasonable number of
potential outcomes. Contingent rentals based on interest rate
changes would be estimated using spot rates.
a.
Amounts payable under purchase options would be
excluded from the present value of lease payments
calculation
calculation.
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
86
43
Lessee Accounting – Lease Payments
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
b.
When determining the present value of lease payments,
the lessee must include contingent rents, residual value
guarantees, and expected payments under termination
penalties.
KEY POINT
This represents a major change from the current lease accounting guidance under
GAAP and IAS that call for the exclusion of contingent rents from the minimum lease
payment calculation regardless of their probability of occurrence.
2.
Initial Measurement: The underlying asset would be initially
measured at the amount of the liability and adjusted for any
prepaid lease rentals and any recoverable initial direct costs
that the lessee incurs.
87
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Lessee Accounting – Lease Payments
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
3.
Timing of Recognition: The asset and liability would be
measured at the inception of the lease, but neither would be
recognized until the date that the lessor makes the underlying
asset available to the lessee for use.
KEY POINT
Under the exposure draft, contingent rents are required to be
estimated and included in the minimum lease payment calculation that
is recorded at the commencement of the lease. The current guidance
under GAAP calls for the exclusion of contingent rents from the
minimum calculation regardless of their probability of occurrence.
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
88
44
Lessee Accounting – Subsequent
Measurement
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
V. Subsequent Measurement
A.
B.
Reassess the carrying amount of the lease payment obligation if there
is a significant change
Accounting for Subsequent Measurement
1. Changes in lease terms: Adjust the right-of-use asset and the
obligation to make rental payments
2. Changes to assumptions (contingent rents, GRV and termination
penalties): Reflected in earnings if change arises from current or
prior reporting periods
3. Changes related to future reporting periods: Adjust the right-ofg
to make rental p
payments
y
use asset and the obligation
KEY POINT
No changes required for the incremental borrowing rate. The discount rate is locked
in at initial measurement
89
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Lessee Accounting – Financial Reporting
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
VI.
Presentation
A.
Balance Sheet
1.
Right of use assets presented with PP&E but separate from nonnon
lease assets.
a.
2.
Lease obligation presented separate from other liabilities.
a.
B.
C.
Amortization term of LHIs to coincide with lease term.
Could affect leverage covenants.
Income Statement
1.
Straight-line expense replaced with amortization and interest
expense.
2.
Foreign exchange differences related to the liability to make lease
payments.
Statement of Cash Flows
1.
Cash payments shown as financing activity.
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CONTINUING PROFESSIONAL EDUCATION
D. Updated Requirements – Tentative Decisions as of July 21, 2011
1.
Statement of Financial Position - Lessees may separately
present
p
ese t or
o disclose
d sc ose tthe
e values
a ues related
e ated to right
g to
of use assets
and liabilities.
a.
If they do not separately present they must disclose in
what account the values are included.
b.
The right of use assets should be presented as if they are
owned assets.
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Lessee Accounting – Financial Reporting
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
2.
Statement of Cash Flows:
a.
Cash paid for leases payments is classified in financing
act t es
activities.
b.
Classify or disclose the cash paid relating to interest using
U.S. GAAP or IFRS.
c.
Classify cash paid for variable lease payments not
included in the measurement of the liability to make
lease payments as operating activities. (FASB: 4 to 3;
IASB: 13 IASB to 2).
d. Cash paid for short-term leases not included in the
lease liability value are treated as operating activities.
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
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BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
Lessee Accounting – Financial Reporting
91
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
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VII. Disclosure
A.
As of the July 21st meeting the boards tentatively decided on the
g disclosure requirements:
q
following
1.
A reconciliation of the opening and closing balance of right-of-use
assets, disaggregated by class of underlying asset.
2.
A reconciliation of the opening and closing balance of the liability
to make lease payments – disaggregation is not required as it was
in the ED.
3.
Maturity analysis of the undiscounted cash flows that are included
in the liability to make lease payments
payments. The maturity analysis
should show, at a minimum, the undiscounted cash flows to be
paid in each of the first five years after the reporting date and a
total of the amounts for the years thereafter. The analysis should
reconcile to the liability to make lease payments.
90
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Lessee Accounting – Financial Reporting
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
4.
Information about the principal terms of any lease that has not yet
commenced if the lease creates significant rights and obligations
for the lessee.
5.
Information required in paragraphs 73(a)(ii)-73(a)(iii) of the
exposure draft (additional guidance pending on this item.)
6.
All expenses relating to leases recognized in the reporting period,
in a tabular format, disaggregated into (a) amortization expense,
(b) interest expense, (c) expense relating to variable lease
payments not included in the liability to make lease payments, and
(d) expense for those leases for which the short-term practical
expedient is elected, to be followed by the principal and interest
paid on the liability to make lease payments.
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CONTINUING PROFESSIONAL EDUCATION
7. Qualitative information to indicate if circumstances or expectations
about short-term lease arrangements are present that would result in a
material change to the expense in the next reporting period as
compared with the current reporting period
B.
Tentatively the boards agreed these items do not require disclosure:
1.
The discount rate and range of discount rates used to calculate the
liabilities to make lease payments.
2.
The fair value of the liability to make lease payments.
3.
The existence and principal terms of any options to purchase the
underlying asset,
asset or initial direct costs incurred on a lease
lease.
4.
Information about arrangements that are no longer determined to
contain a lease.
90
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Lessee Accounting – Financial Reporting
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C. Future Commitments – The 2 Boards Differ on This Point.
1 FASB: lessee should disclose the future contractual
1.
commitments associated with services and other non-lease
components that are separated from a lease contract.
2. IASB: lessee is not required to disclose the future
contractual commitments associated with services and
other non-lease components that are separated from a
lease contract.
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Accounting for Leases
General Provisions of Lease
Accounting
Developments in Lease
Accounting
Lessee Accounting
Lessor Accounting
FASB Proposed ASU
Other Lease Accounting Topics
Effects on Financial Reporting
Transition and Effective Date
94
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Lessor Accounting – General
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
I.
Dual Model
A. Performance Obligation Approach
1. Lease receivable and liability
y to permit
p
lessee’s use of asset
2. Interest income and lease income as obligation is satisfied
B. De-recognition Approach
1. Used only if lessor does not retain significant risks and rewards
of ownership of leased asset
2. Up-front gain for de-recognition of leased asset
KEY POINT
Ownership transfers at end of lease (upon final payment or required buyout)
Written option for bargain purchase
Ninety (90%) percent of leased property F.V. <= P.V. of lease payments
Seventy-five (75%) percent of asset economic life is being committed in lease term
Operating Leases
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Lessor Accounting – General
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
II.
Estimates for Both
A. Lease term, contingent payments, other assumptions similar to
essee accou
accounting.
t g
lessee
B. Predict lessee’s behavior as to whether or not lessee is likely to
exercise the options built into the lease
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
Lessor Accounting – General
96
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
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Lessor Accounting – General
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
III.
Performance Obligation Approach
KEY POINT
Ownership
p transfers at end of lease ((upon
p final p
payment
y
or required
q
buyout)
y )
Written option for bargain purchase
Ninety (90%) percent of leased property F.V. <= P.V. of lease payments
Seventy-five (75%) percent of asset economic life is being committed in lease term
Operating Leases
A. When risks and benefits of underlying asset are retained, lessor
considers:
1.
Significance of contingent rentals during the expected lease
term based on performance or use of the underlying asset,
2.
Options to extend or terminate the lease, or
3.
Material non-distinct services provided in the lease contract.
98
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Lessor Accounting – General
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
B. The underlying leased asset remains on the lessor’s balance
sheet.
C. The
C
e lessor
esso recognizes:
ecog es
1.
A lease receivable (right to receive rental payments from the
lessee).
2.
A corresponding performance obligation / lease obligation.
D. As the performance obligation is satisfied, revenue is recognized.
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
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Lessor Accounting – General
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
E.
Subsequent measurement: Performance obligation approach
Subsequent measurement of the lessor’s receivable would be at
amortized cost using the effective interest method, resulting in interest
income.
income
1. The exposure draft proposes that, from the time that the lease is
commenced, the lessor would measure its lease asset at
amortized cost using the effective interest method and recognize
any impairments in accordance with IAS 39 Financial Instruments:
Recognition and Measurements.
a) The right to receive lease payments is amortized over the
life of the lease, and the lessor recognizes interest income
using the interest method.
b) To amortize the performance obligation, the lessor must
use a rational and systematic approach based on pattern of
use. If none exists, straight-line amortization should be
used.
100
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Lessor Accounting – General
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
F.
Reassessment: Performance Obligation Approach
1.
The exposure draft requires the lessor to reassess the amount of
p
lease p
payments,
y
, the lease term,, contingent
g
rentals,,
expected
termination options, and residual value guarantees each reporting
period if the facts or circumstances indicate that a significant
change in the right to receive rental payments has occurred.
2.
Accounting for Changes
a)
Changes to lease term: Adjust the lease liability and the right
to receive lease payments.
b)
For contingent cash flows:
1)
Recognize in revenue, if the performance obligation has
been already satisfied
2)
Recognize as an adjustment to performance obligation if
obligation has not yet been satisfied
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Lessor Accounting – General
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
G. Presentation: Performance Obligation Approach
Performance Obligation – Lessor Financial Statement Presentation
Balance Sheet
Underlying Asset
xx
Right to Receive Lease Payments
Lease Liability
xx
(xx)
Net Lease Asset / (Liability)
xx
Income Statement
Lease Income
xx
Depreciation Expense
(xx)
Interest Income
xx
Source: August 2010, IASB Exposure Draft Snap Shot: Leases
102
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Lessor Accounting – General
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
IV.
Derecognition Approach:
V.
KEY POINT
Ownership
p transfers at end of lease ((upon
p final p
payment
y
or required
q
buyout)
y )
Written option for bargain purchase
Ninety (90%) percent of leased property F.V. <= P.V. of lease payments
Seventy-five (75%) percent of asset economic life is being committed in lease term
Operating Leases
A.
Assumes that the lessor has performed by delivering the leased asset
and providing an unconditional right to use it over the lease term.
B.
The lessor recognizes:
1.
A receivable (right to receive rental payments from the lessee) and
2.
Records revenue
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Lessor Accounting – General
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CONTINUING PROFESSIONAL EDUCATION
C.
D.
A portion of the carrying value of the leased asset is viewed as having
transferred to the lessee, is derecognized and recorded as cost of sales
The amount derecognized:
1
1.
Based on the relationship between the fair value of the receivable from the
lessee and the fair value of the underlying asset
2.
Determined at inception of the lease
E.
The lessor would not remeasure the residual asset retained, except for
impairment.
F.
The value of the residual asset would not be accreted over time
KEY POINT
Note that, although the exposure draft would require the lessor to recognize income and
expense at the time the lease is commenced, the amount of profit recognized initially may
differ from that recognized under a sales-type lease under the current GAAP rules. This is
because the guidance in the exposure draft differs from the current lease accounting
guidance with regards to contingent rentals, residual value guarantees, and other
elements of lease contracts.
104
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Lessor Accounting – General
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
G. Subsequent Measurement: Derecognition Approach
1.
The exposure draft proposes that, from the onset of the lease, the
g the
lessor would measure the leased asset at amortized cost using
effective interest method and recognize any impairment in
accordance with the guidance set forth in IAS 39.
2.
The lessor would reassess its lease liability similar to how the
lessee would reassess its liability except that the lessor would:
a)
Allocate any change in the carrying amount of the leased
asset that is attributable to a reassessment of the lease
profit and loss;; and
term between the residual asset and p
b)
Recognize other changes in the carrying amount of the
leased asset in profit or loss.
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3.
The residual asset would not be remeasured unless there is a
change in lease term or a subsequent impairment of the
underlying asset.
4.
Note: The lessor would apply the guidance set forth in ASC
(IAS 39) as of each reporting date to determine whether its
right to lease payments has been impaired, and it would apply
the guidance in ASC 350 (IAS 36) to determine whether the
residual asset has been impaired.
Source: KPMG IFRS Briefing Sheet August 2010, Issue 205 and Deloitte, FASB Draws a Bright Line Through Operating Leases, Volume 17,
Issue 27
106
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Lessor Accounting – Changes in Estimate
BECKER GEARTY
and Remeasurement
CONTINUING PROFESSIONAL EDUCATION
H.
Reassessment: Derecognition Approach:
1.
Reassessment resulting in a change in term - change in the
ease receivable
ece ab e is
sa
allocated
ocated to tthe
e rights
g ts de
derecognized
ecog ed a
and
d tthe
e
lease
residual asset.
2.
For contingent cash flows, changes in the lease receivable are
adjusted through revenues.
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Lessor Accounting – Changes in Estimate
BECKER GEARTY
and Remeasurement
CONTINUING PROFESSIONAL EDUCATION
I.
I.
Presentation: Derecognition Approach:
1.
The exposure draft provides that the lessor would present the
leased asset separate from other financial assets and the residual
asset separately within property, plant, and equipment in the
statement of financial position.
2.
Presentation in profit or loss would depend on the lessor’s
business model:
a.
If the lessor uses the leases for the purposes of financing,
then net lease income and expense would be presented as
g line item; and
a single
b.
If the lessor uses the leases as an alternative to selling the
asset, then net lease income and expense would be
presented as separate line items.
Source: KPMG IFRS Briefing Sheet August 2010, Issue 205 and Deloitte, FASB Draws a Bright Line Through Operating Leases, Volume 17,
Issue 27
108
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Lessor Accounting – Changes in Estimate
BECKER GEARTY
and Remeasurement
CONTINUING PROFESSIONAL EDUCATION
V.
Current Status
A.
Lessor accounting is still in flux. The information presented
e e reflects
e ects tthe
eo
original
g a e
exposure
posu e d
draft.
a t There
e e is
s much
uc
here
ongoing deliberation on this topic including whether there
should be 1 or 2 approaches to lessor accounting. Until such
time as the boards agree on which approach it is beneficial to
understand the original exposure draft and take note of the
subsequent points here as to significant open issues.
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and Remeasurement
CONTINUING PROFESSIONAL EDUCATION
Current Status
B.
May 17, 2011 meeting
1
1.
Discussed whether there should be one or two
approaches to lessor accounting. This discussion is to be
continued at a future meeting.
2.
They will consider the implications from requiring lessees
to use a single approach
3.
They discussed a number of related topics and requested
the staff to investigate further and report back. To date
this meeting to review has not occurred.
4.
They indicated a preference to treating leases like other
financial instruments but requested the staff to investigate
if this would have unintentional consequences if two
approaches were selected for lessor accounting.
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Leases – 2010 Exposure Draft
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
•
.
KEY POINT
If a single
i l approach
h iis used,
d th
the b
boards
d ttentatively
t ti l d
decided
id d th
that:
t
1. The lessor would derecognize a portion of the carrying amount of the
underlying asset. (FASB: unanimous; IASB: 12 to 2).
2. The lessor would initially measure the residual asset as an allocation of the
carrying amount of the underlying asset. (FASB: unanimous; IASB: unanimous).
3. The lessor would subsequently measure the residual asset by accreting the
amount of the residual asset over the lease term, using the rate that the lessor
charges the lessee
lessee. (FASB: 5 to 2; IASB: unanimous)
unanimous).
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Lessor Accounting – Changes in Estimate
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and Remeasurement
CONTINUING PROFESSIONAL EDUCATION
V.
Current Status
C.
The following issues were discussed at the June 14, 2011
meeting the boards.
1.
The boards discussed a single approach to lessor accounting
whereby the lessor would recognize a lease receivable and a
residual asset at lease commencement. In subsequent
meetings this is known as the receivable–residual approach.
2.
The boards will discuss at a future meeting whether and
when, under such an approach, it is appropriate for a lessor
g
p
profit at lease commencement.
to recognize
3.
The boards will also discuss at a future meeting whether
there should be different lessor models for:
a.
a lease of a portion of an asset and
b.
a lease of an entire asset.
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Lessor Accounting – Changes in Estimate
BECKER GEARTY
and Remeasurement
CONTINUING PROFESSIONAL EDUCATION
D. Tentative decisions from the July 20, 2011 meeting on how
to apply the Receivable-Residual Approach
1 Recognize the right to receive lease payments and a
1.
residual asset at commencement date.
2.
Measure the right to receive lease payments at the sum
of the present value of the lease payments, discounted
using the rate the lessor charges the lessee.
3.
Measure the residual asset as an allocation of the
y g amount of the underlying
y g asset. Subsequently
y
carrying
measure the residual asset by accreting it over the
lease term using the rate the lessor charges the lessee.
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Lessor Accounting – Changes in Estimate
BECKER GEARTY
and Remeasurement
CONTINUING PROFESSIONAL EDUCATION
4.
If profit on the right-of-use asset transferred to the lessee is
reasonably assured, recognize that profit at the date of the
commencement of the lease.
5.
If profit on the right-of-use asset transferred to the lessee is
not reasonably assured, recognize that profit over the lease
term.
a)
6.
Residual Asset = Difference in carrying amount of the
asset and the right to receive lease payments. Accrete
the residual asset so at the end of the lease the value will
be as it would have been if lessor had been depreciating
the asset.
If the right to receive lease payments is greater than the
carrying amount of the underlying asset at the date of the
commencement, recognize, as a minimum, the difference
between those two amounts as profit at that date.
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Lessor Accounting – Changes in Estimate
BECKER GEARTY
and Remeasurement
CONTINUING PROFESSIONAL EDUCATION
7.
Leases of investment property measured at fair value and
short-term leases are excluded from the receivable-residual
pp
approach.
a)
8.
Lessors will continue to depreciate those assets
and recognize lease income systematically over the
lease term.
Noted Open Issues:
1.
Leases tied to an index – presentation for the lessor.
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Lessor Accounting – Changes in Estimate
BECKER GEARTY
and Remeasurement
CONTINUING PROFESSIONAL EDUCATION
EXAMPLE
Derecognition – Lessor Financial Statement Presentation
B l
Balance
Sheet
Sh t
Residual Asset
xx
Right to Receive Lease Payments
xx
Income Statement
Revenue
xx
Cost of Goods Sold
(xx)
(gross or net based on business model)
$
Interest Income
xx
Source: August 2010, IASB Exposure Draft Snap Shot: Leases
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BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Accounting for Leases
Developments in Lease
Accounting
FASB Proposed ASU
General Provisions of Lease
Accounting
Lessee Accounting
Lessor Accounting
Other Lease Accounting
Topics
Effects on Financial Reporting
Transition and Effective Date
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Other Lease Accounting Issues
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
I.
Short-term Leases
A.
Lease terms 12 months or less (including renewals).
B.
Lessee and Lessor may elect to use the lease guidance, or
C.
Lessee may recognize lease payments in profit or loss on a straightline basis over the lease term.
D.
Lessor would not record in the statement of financial position.
E.
Required disclosures for this treatment are not yet finalized.
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Other Lease Accounting Issues
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
II. Sale-Leasebacks
A. Update from March 22, 2011 Meeting
1. Boards affirmed the decision that when a sale has
occurred, the transaction would be accounted for as a
sale and then a leaseback.
2. Tentatively decided that an entity should apply the
control criteria described in the revenue recognition
project to determine whether a sale has occurred.
3. Affirmed that the seller/lessee would adopt the whole
asset which deems that, the seller/lessee sells the
entire underlying asset and leases back a right-of-use
right of use
asset relating to part of the underlying asset.
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Other Lease Accounting Issues
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
4. Tentatively decided that the leases guidance would not
prescribe a particular type of lessee accounting model
for entities that are accounting for the leaseback part of
a sale and leaseback transaction
transaction.
5. Affirmed the decision that in a transaction accounted for
as a sale and leaseback:
a. When the consideration is at fair value, the gains
and losses arising from the transaction should be
recognized when the sale occurs.
b. When the consideration is not established at fair
a ue, the
t e assets, liabilities,
ab t es, gains
ga s and
a d losses
osses
value,
recognized should be adjusted to reflect current
market rentals.
113
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Other Lease Accounting Issues
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
III.
Subleases
A.
Account for head lease and sub-lease as separate transactions.
B.
An intermediate lessor, as a lessee in a head lease arrangement,
should account for its assets and liabilities arising from the head lease
in accordance with the decisions-to-date for all lessees. (FASB:
unanimous; IASB: unanimous).
C.
An intermediate lessor, as a lessor in a sublease arrangement, should
account for its assets and liabilities arising from the sublease in
accordance with the decisions-to-date for all lessors. (FASB:
unanimous; IASB: unanimous))
D.
If the boards decide that there should be more than one approach to
lessor accounting, an intermediate lessor, as a lessor in a sublease,
should evaluate its right-of-use asset, not the underlying asset, to
subleases.
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Other Lease Accounting Issues
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Cash
Accounts Receivable
$
Property, Plant and Equipment
Right of use asset
Sublease receivables
Sublease liabilities
Net sublease assets
X
X
X
X
X
(X)
X
Total Assets
$
X
Accounts payable & accrued expenses
Li bilit tto make
Liability
k llease payments
t
$
X
X
Total Liabilities
$
X
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BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
General Provisions of Lease
Accounting
Accounting for Leases
Lessee Accounting
Developments in Lease
Accounting
Lessor Accounting
Other Lease Accounting Topics
FASB Proposed ASU
Effects on Financial Reporting
Transition and Effective Date
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Lease Accounting
Financial Reporting
I.
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Balance Sheet
A. Current pro-forma capitalizations of operating leases are likely to
understate
u
de state to a
amounts
ou ts p
presented
ese ted u
under
de tthe
e new
e lease
ease model.
ode
Asset Turnover Ratio
Reported Assets are
Higher
Return on Equity
Debt--to
Debt
to--Equity Ratio
Current & NonNon-current
Liabilities are Higher
Working Capital
116
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Lease Accounting
Financial Reporting
II.
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Income Statement
EBIT
Lower rent expense partially offset
ff
by
increased amortization
OM
Earnings
Higher amortization expense and
interest expense
EPS
Statement of Cash Flows
Cash flows associated with leases are
classified as financing activities
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Operating Cash Flow
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Disclosures
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
III.
Disclose:
A. Quantitative and qualitative information identifying and explaining
amounts
a
ou ts recognized
ecog ed in tthe
e financial
a c a state
statements
e ts a
arising
s g from
o leases.
eases
B. Description of how leases affect the amount, timing and uncertainty
of the company’s future cash flows.
C. The nature of the company’s lease arrangements; and
D. Information about the principal terms of any lease that has not yet
commenced if the lease creates significant rights and obligations
for the company.
118
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Disclosures
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
IV. Disclose:
A. A reconciliation between the opening and closing balances of rightof-use
o
use assets and
a d obligations
ob gat o s to pay rentals,
e ta s, d
disaggregated
sagg egated by
class of underlying asset.
B. A narrative disclosure of significant assumptions and judgments
relating to renewal options, contingent cash flows, and the discount
rate used.
C. A maturity analysis of the gross obligation to pay rentals showing:
1.
Undiscounted cash flows on an annual basis for the first five
years and a total off the amounts for
f the remaining years and
2.
Amounts attributable to the minimum amounts specified in the
lease and the amounts recognized in the balance sheet
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66
Disclosures
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
V.
Disclose:
A. Under the performance obligation approach:
1
1.
Lessors would classify collection of the lease receivable and
interest income arising from that receivable as operating
activities in the statement of cash flows.
B. Additional disclosures would apply if:
1.
The simplified option for short-term leases is elected,
2.
Significant subleases exist, or
3.
There is a sale-leaseback transaction
120
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
Disclosures
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Lessee - Reconciliation Roll-forward Disclosure
Right-of-use
Assets
Balance at January 1, 20X0
Changes in estimates from:
Options
Contingent rentals
Residual value guarantees
Subtotal for changes in estimates
$
$
(1,000)
50
40
10
100
Revaluations (for IFRS)
Additions for new right-of-use assets/
(obligations)
Impairments
Accumulated Amortization at January
1, 20X0
Amortization during year
Accumulated Amortization at
December 31, 20X0
Disposals of right-of-use assets/
(obligations)
Repayments of obligations
Balance at December 31, 20X0
1,000
Liability to make
Lease Payments
(50)
20
(10)
(40)
25
$
Total
Total Obligations
XX
XX
XX
XX
XX
XX
$
XXX
XX
XX
XX
XX
XX
XX
$
XXX
-
200
1,325
(100)
(200)
(1,240)
-
(400)
(40)
-
(440)
-
(30)
755
Contractual
Obligations
20X0
20X1
20X2
20X3
20X4
20X5 and Thereafter
$
30
80
(1,130)
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
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67
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
General Provisions of Lease
Accounting
Lessee Accounting
Accounting for Leases
Lessor Accounting
Developments in Lease
Accounting
Other Lease Accounting Topics
FASB Proposed ASU
Transition and Effective Date
Effects on Financial Reporting
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
Lease Accounting
Transition and Effective Date
I.
122
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Effective Date
A. Not yet determined.
B Most likely 2013.
B.
2013
C. Some believe it may be later.
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
123
68
Lease Accounting
Transition and Effective Date
II.
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Transition
A. No grand-fathering
B. Required to inventory all lease contracts and for each:
1. Determine the lease term and
2. Effect of contingent payments, GRVs, and termination payments
C. Applied as of beginning of first comparative period presented. All lease
contracts are effectively reset to year one of adoption of the final
standard.
D. Requires hindsight of assumptions.
E. Uses simplified retrospective method.
F. Consider leases expiring before effective date but part of comparative
period
G. Remove Deferred FASB Rent, Capital Lease Obligations & Assets
H. Effect on net income can be significant because the model produces
higher aggregate expense in early periods of a lease term
I. Deferred Tax and Sales/ Use Tax Considerations
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
Lease Accounting
Other Considerations
1.
Valuations of Leases in M&A
2.
Accounting for tenant incentives
3
3.
IT systems for tracking
4.
Controls over assumptions
5.
When to re-measure assumptions
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124
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
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69
Lease Accounting
General Update
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
A. The boards to date have addressed a number of topics but there are
still a number of topics under discussion including:
1.
One
O
e or
o ttwo
o app
approaches
oac es for
o lessor
esso accou
accounting
t g
2.
Disclosure on short term leases
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
125
BECKER GEARTY
CONTINUING PROFESSIONAL EDUCATION
Final Polling Question:
Which is your preference?
A. Questions.
B. Comments.
C. Just give me my CPE Certificate!
Thank you!
© 2011 DeVry/Becker Educational Development Corp. All rights reserved.
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