FASB/IASB Lease Accounting
Project
The Effects on Lessee Financial Statements
Leaseurope/FLA Business Forum
May 22, 2009
Lease Accounting Project Impact
Presenter
Bill Bosco
Consultant, Leasing 101
ELFA Technical Advisor
914-522-3233
wbleasing101@aol.com
Lease Accounting Project Impact
Agenda
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The new direction
Lessee impacts
Who is impacted?
Capitalization calculator
Case study
Summary and Q&A
Analysis – The 2008 version
Overall Model – best realistic outcome we could hope for!
- But the project has a long way to go!
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Right of use model = lowest capitalization for lessees
Fair valuing lessee options and RV Guarantees = minimal value
based on FMV/UAB curves, BUT could add complexity to lessee
accounting and potential P&L volatility
Right to terminate defines lease term* = low capitalization
Lessor accounting = direct finance lease accounting (no
operating leases)
There is sympathy for simplicity in lessee accounting for
immaterial leases.
Lessor accounting similar to direct finance lease accounting
(they will review this carefully)
BUT EVERYTHING HAS CHANGED!!!!!!!!
Analysis – The 2009 version
Overall Model – Capitalizes more than current GAAP
with complex calculations and adjustments
ignoring lease economics
• Lessee only rules change
• Estimate lease term and payments (renewals,
contingent rents & PO’s) and capitalize at
incremental borrowing rate with continual
adjustments to estimates
• Treat all leases as a purchase of an asset and a loan.
SL depreciation and imputed interest replace SL
rent expense
• “Fixes” liability issue – but misrepresents the lease
asset, P&L and cash flow statement
Analysis – The 2009 version
Lessee impacts to be analyzed
• Complexity for little benefit but much cost
and confusion
• P&L cost is front ended (accelerated)
• Asset value is de-linked from liability
value
• Deferred tax accounting for all leases
• Cash flow statement = financed CAPEX
Lease Accounting Project Impact
US Market Info
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ELFA estimates >75% of the $ in operating lease rents are from real
estate leases
All companies lease and ELFA estimates are 90-99% of leases by
numbers are equipment leases
Proposed rules will be a a burden for lessees as the vast majority of
leases are insignificant.
2008 US equipment lease statistics are:
Segment
$ Range
% of $
% of #
Micro
<$25k
5.4%
52.4%
Small
$25-250k
26.1%
42.5%
Mid
$250k-5m
49.3%
4.7%
Large
>$5m
19.2%
0.4%
100.0%
100.0%
Totals
Lease Accounting Project Impact
US Market Info
• Walgreen’s is the largest lessee with 21
billion in off balance sheet rent
obligations.
• Retailers dominate the numbers with 15
of the top 30 – due to real estate leases
that can’t be anything but rentals if they
want to be in malls.
The Lease Accounting Project
Com pany Nam e
YR 1
YR 2
YR3
YR 4
YR 5
Beyond
Total
Walgreen Co.
1,309.3
1,345.9
1,309.0
1,242.1
1,215.0
15,455.4
21,876.7
Continental Airlines Inc.
1,388.0
1,330.0
1,293.0
1,253.0
1,210.0
12,516.0
18,990.0
CVS Corp.
1,181.3
1,120.8
1,060.0
1,008.1
972.8
9,997.1
15,340.1
AMERICAN AIRLINES INC
1,093.0
1,037.0
972.0
956.0
912.0
8,387.0
13,357.0
808.0
722.0
645.0
596.0
573.0
7,827.0
11,171.0
FedEx Corp.
1,707.0
1,555.0
1,436.0
1,329.0
1,169.0
7,820.0
15,016.0
AMR Corp.
1,092.0
1,022.0
996.0
938.0
840.0
7,534.0
12,422.0
McDonald's Corp.
1,061.7
999.7
929.1
865.0
806.6
6,780.5
11,442.6
Kohl's Corp.
314.6
324.0
317.0
311.1
311.1
6,218.4
7,796.2
Wal-Mart Stores Inc.
730.0
700.0
626.0
578.0
530.0
5,908.0
9,072.0
Northw est Airlines Corp.
788.0
794.0
803.0
767.0
744.0
5,857.0
9,753.0
Hom e Depot Inc.
660.0
613.0
566.0
514.0
464.0
5,113.0
7,930.0
General Motors Corp.
898.0
946.0
782.0
1,290.0
674.0
4,249.0
8,839.0
Kroger Co.
784.0
746.0
691.0
644.0
595.0
4,201.0
7,661.0
Suncor Energy Inc.
144.7
154.0
159.4
161.7
171.0
3,753.0
4,543.8
Rite Aid Corp.
543.9
516.4
481.2
451.1
419.7
3,521.9
5,934.2
Sprint Corp. (FON Group)
1,251.0
1,094.0
899.0
729.0
619.0
3,511.0
8,103.0
EDISON MISSION ENERGY
317.0
355.0
353.0
352.0
348.0
3,300.0
5,025.0
Burlington Northern Santa Fe C
492.0
454.0
407.0
398.0
381.0
3,280.0
5,412.0
Albertsons Inc.
429.0
409.0
388.0
357.0
330.0
3,088.0
5,001.0
1,297.0
988.0
861.0
743.0
626.0
2,967.0
7,482.0
Safew ay Inc.
405.9
396.8
380.9
362.5
328.3
2,778.6
4,653.0
Best Buy Co. Inc.
454.0
424.0
391.0
385.0
379.0
2,621.0
4,654.0
1,383.0
1,231.0
1,009.0
849.0
764.0
2,482.0
7,718.0
Sears Holdings Corp.
451.0
429.0
391.0
358.0
321.0
2,447.0
4,397.0
Staples Inc.
576.2
554.8
521.3
483.0
454.2
2,445.1
5,034.5
Regal Entertainm ent Group
277.2
274.3
274.2
274.4
272.1
2,409.0
3,781.2
Target Corp.
146.0
142.0
137.0
117.0
102.0
2,405.0
3,049.0
MetLife Inc.
603.0
582.0
541.0
465.0
400.0
2,332.0
4,923.0
Winn-Dixie Stores Inc.
402.2
369.7
350.3
334.2
316.8
2,320.8
4,094.0
CINGULAR WIRELESS LLC
Citigroup Inc.
General Electric Co.
Lease Accounting Project Impact
Lease Capitalization Calculator
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Case Study – Bank Of America under the new rules
– BofA’s annual operating lease commitments for the next 5 years
and thereafter in $billions are: $2.3, 2.1, 1.8, 1.5, 1.2, and 8.3
– Assuming a 7% discount rate and Moody’s style capitalization
calculations, $12 billion in assets and liabilities will be added to
the balance sheet and lease expense will increase by $300
million
– Long term debt increases by 5%, earnings drop by 5%
– Increased capital needs are $1 billion for the increased assets
and $200 million for the accelerated lease costs
– Recent news from US bank stress tests is that BofA needs to
raise $34 billion in new capital based on current accounting
– Is this the latest loss of capital due to new accounting theories?
Lease Accounting Project Impact
Lease Capitalization Calculator
Input:
YEARS
Future op lease pm ts
1
2
3
4
5
$2,300
$2,100
$1,800
$1,500
$1,200
thereafter
$8,300
7.00%
Discount rate
Com parative Financial Inform ation
Assets
Years
Liabilties
P&L
P&L B/(W)
CUR GAAP PROP GAAP CUR GAAP PROP GAAP CUR GAAP PROP GAAP
$
%
1
$0
$12,009
$0
$12,009
$2,300
$2,605
($305)
-13%
2
$0
$10,245
$0
$10,550
$2,100
$2,316
($216)
-10%
3
$0
$8,667
$0
$9,188
$1,800
$1,949
($149)
-8%
4
$0
$7,361
$0
$8,031
$1,500
$1,606
($106)
-7%
5
$0
$6,318
$0
$7,094
$1,200
$1,286
($86)
-7%
6
$0
$5,528
$0
$6,390
$1,186
$1,237
($51)
-4%
7
$0
$4,738
$0
$5,652
$1,186
$1,185
$0
0%
8
$0
$3,948
$0
$4,862
$1,186
$1,130
$56
5%
9
$0
$3,159
$0
$4,016
$1,186
$1,071
$115
10%
10
$0
$2,369
$0
$3,112
$1,186
$1,008
$178
15%
11
$0
$1,579
$0
$2,144
$1,186
$940
$246
21%
12
$0
$790
$0
$1,108
$1,186
$867
$318
27%
13
$0
$0
$0
($0)
$0
($0)
$0
#DIV/0!
14
$0
$0
$0
($0)
$0
($0)
$0
#DIV/0!
15
$0
$0
$0
($0)
$0
$0
$0
#DIV/0!
$17,200
$17,200
Totals
Lease Accounting Project Impact
Pro Forma Financials
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Case Study – 10 year lease under the new rules
– The proposed rules for a former operating lease will look like
PP&E purchase and loan accounting with estimated contingent
rents and renewals capitalized and reviewed and adjusted
continually
– In the US the tax treatment is operating lease treatment creating
a book/tax difference and the need for deferred tax accounting
– The ELFA proposes to account for the P&L on a straight line
basis to reflect economic reality
– This means amortizing the asset and liability using “mortgage
amortization” against rent expense, accruing the average rent
expense and charging the rent payment to accrued rent payable
– Results of the new approach:
• Year 1 rent expense 21% higher than SL
• Cumulative expense distortion 64% through year 5
Lease Accounting Project Impact
Pro Forma Financials
Office space lease - assumptions
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Square feet
15,000
Rent rate per sq ft
$30
Annual rent in $
$450,000
Payment timing
arrears
Term in years
10
Inception month
January
Lessee incr borrowing rate
8.00%
PV of rents
$3,019,537
Tax treatment
true lease
Annual tax deduction
$450,000
Income tax rate
40.00%
Lease Accounting Project Impact
Pro Forma Financials
Journal entries - Capital lease accounting as proposed by DP
dr Equipment
cr Capitalized lease obligation
To capitalize the lease
3,019,537
dr Depreciation expense
cr Accumulated depreciation
To depreciate the asset in 1st mo
301,954
3,019,537
301,954
dr Interest expense
241,563
dr Capitalized lease obligation
208,437
cr Cash
450,000
To record 1st mo rent payment, cap lease obligation amort & imputed interest
dr Current taxes payable
37,407
cr Deferred taxes payable
37,407
To record tax impact of temporary book/tax difference
Lease Accounting Project Impact
Pro Forma Financials
Journal entries – Right-of-use lease accounting as proposed by ELFA
dr Right to use equipment
cr Capitalized lease obligation
To capitalize the lease
3,019,537
3,019,537
dr Capitalized lease obligation
208,437
cr Rent expense
208,437
dr Rent expense
208,437
cr Right to use equipment
208,437
To amortize 1st year right to use asset & lease obligation
dr Rent expense
cr Accrued rent payable
To accrue 1st year rent expense
450,000
dr Accrued rent payable
cr Cash
To record rent payment
450,000
450,000
450,000
Lease Accounting Project Impact
Pro Forma Financials
Balance sheet
Equipment
Cap lease obligation
Deferred tax liability
P&L
Depreciation
Interest expense
Tax expense
Net after tax cost
Balance sheet
Right to use equip
Cap lease obligation
Comparative Financial Statements - Capitalized lease accounting
YR 1
YR 2
YR 3 YR 4 YR 5
YR 6 YR 7 YR 8 YR 9
2,717
2,415 2,113 1,811 1,509 1,207
905 603
301
2,811
2,585 2,342 2,080 1,796 1,490 1,159 802
416
37
68
91
107
114
113
101
79
45
301
241
217
326
YR 1
2,811
2,811
301
224
210
316
301
206
203
305
301
187
195
293
301
166
187
281
301
143
178
267
301
119
168
252
301
92
157
236
YR 10
0
0
0
301
64
146
219
301
33
134
201
Right to use accounting
YR2
YR 3
YR 4
YR 5
YR 6 YR 7 YR 8 YR 9 YR 10
2,585
2,342 2,080 1,796 1,490 1,159 802
416
0
2,585
2,342
2,080 1,796 1,490 1,159 802
416
0
P&L
Rent expense
Tax expense
Net after tax cost
Diff in AT Income
450
180
270
(56)
450
180
270
(46)
% Diff in AT income
21%
17%
450
180
270
(35)
450
180
270
(23)
450
1 80
270
(11)
13%
9%
4%
Cumulative 64%
450
180
270
2
1%
450
180
270
17
6%
450
180
270
33
12%
450
180
270
50
9%
450
180
270
68
26%
Lease Accounting Project Impact
Cash Flow Statement Impact
Category Of Cash
Now
Proposed
Operating Activities
Rent is cash outflow
Depreciation and
interest added back
Investing Activities
No activity reported
Capital expenditure
Financing Activities
No activity reported
Proceeds from lease
obligation
Lease payment is
cash outflow
Lease Accounting Project Impact
Implications for Lessees
Preliminary views of rights & obligations at inception in a lease
• EBITDA
improves
(strange
result?)
and whether
they meet
definitions
of an asset/liability are:
• Depreciation/interest vs. rent expense (operating expense)
• Capital needs increase
• Financial institutions impacted
• Debt covenants broken
• Earnings/EPS erode if SL P&L eliminated
• 1st year lease costs increase dramatically (+7% in 3 yr lease,
+21% in 10 yr lease)
• Retailers impacted – after tax earnings hit of 5+% in US
• Transportation & Banks impacted
• Cost/Benefit
• Complex calculations with continuous adjustments
• Lack of clarity, ignores economic reality – worse than buying
• Will customers continue to lease????????
FASB/IASB Lease Accounting
Project
The Effects on Lessee Financial
Statements
Leaseurope/FLA Business Forum
May 22, 2009