Overview - FASB Exposure DraftLeases (Topic 840)
February 2, 2011Douglas Boedeker, CPA, [email protected]
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Course Outline
Why is the exposure draft being issued?
FASB timeline
Project scope
Recording by lessees
Work through an example
Recording by lessors
Transition
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The FASB/IASB Lease Project – WHY?
Leases are an important source of finance – more information required.
Concern over lack of comparability.
Concern over “bright-line” test for operating vs. capital lease.
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FASB Timeline
Exposure Draft Issued – August 17, 2010
Public Comment Period Ended – December 15, 2010
- 778 comment letters were received!
Final standard currently anticipated for release sometime in 2Q2011
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Scope of the proposed standard
Simple – ALL Leases
Except :Leases of intangible assetsLeases of mineral rights, etc.Leases of biological assets
Distinct service components of a lease agreement should be accounted for in accordance with the new ED on revenue from contracts with customers.
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What is a “lease”?
“A contract in which the right to use a specified asset is conveyed, for a period of time, in exchange for consideration.”
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Initial Recording by a Lessee
1. Determine the “lease liability”(Future anticipated cash payments discounted to present value at either the lessee’s incremental borrowing rate or the rate implicit in the contract.)
2. Determine the “right of use asset”(Lease liability plus initial direct costs of acquiring the lease.)
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Subsequent Recording by a Lessee
Amortize the “right of use asset”. (Probably on a straight-line basis.)
Adjust the lease liability using the effective interest rate method.(Essentially treated like a note payable.)
Reassess significant assumptions and adjust for current facts and circumstances. (Discount rate does NOT change.)
Thus, the P&L reflects amortization expense and interest expense.
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Items requiring judgment
The lease term to be used when recording the lease is the longest possible term that is more likely than not to occur.
Contingent rentals must be estimated up-front using a probability analysis.
Payments to be made under residual value guarantees should also be estimated and factored in to the initial lease liability.
At the end of each reporting period the following items must be reassessed and adjusted as necessary:
- Lease term- Contingent rentals and residual value guarantees- Right of use asset (for impairment)
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Term of Lease Probability Cumulative Probability
5 Years 45% 100%
10 Years 30% 55%
15 Years 25% 25%
Assum
e a tenant enters into a five year lease w
ith tw
o five-year renew
al options.
The tenant must
assess the likelihood of w
hether each renew
al option w
ill be exercised.
HIN
T: Alw
ays start this analysis w
ith the longest possible term
at the bottom
and w
ork your way
up!
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Determining the “lease term”
A 10 year term will be used when initially recording the lease.
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Contingent Rents
Let’s assum
e that our lease includes a provision for annual “pass-throughs” based on increases in building operating expenses and property taxes. These are anticipated to start at $50,000 per year.
Our
tenant’s increm
ental borrow
ing rate is 8%
.
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Outcome #1 Outcome #2 Outcome #32% Annual Growth 5% Annual Growth 8% Annual Growth Total
547,486$ 628,895$ 724,328$
Present value at 8% 357,824$ 403,292$ 456,010$
Probability 50% 45% 5%
Expected Outcome 178,912$ 181,481$ 22,801$ 383,194$
Contingent Rent CalculationOperating expense pass-throughs
(Using 10 year lease term)
Gross expenses over lease term
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Calculating the Liability and Asset
Let’s assume that
our lease m
andates annual fixed “base” paym
ents of $1,000,000 per year.
Legal fees of $10,000 w
ere incurred as part of the review
of the lease docum
ent.
Based on the
lease term and
contingent rental analysis perform
ed, the liability and asset are calculated as follow
s……
.
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Gross fixed lease payments - 10 years 10,000,000$
Present value of fixed payments at 8% 6,868,429 Add, present value of contingent rents 383,194
"Lease Liability" 7,251,623
Add, direct costs (legal review) 10,000
"Right of Use" Asset 7,261,623$
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Subsequent entries for year one
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Debit Credit
Entry to account for lease paymentsCash 1,050,000$ Lease liability 493,148$ Interest expense 556,852$
Entry to account for amortization of right of use assetAmortization expense 726,162$ Accumulated amortization 726,162$
Net P&L Impact 1,283,014$
P&L impact under existing GAAP would have only been $1,050,000.
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Lessor Accounting
Does the lessor retain significant risks or benefits of the underlying asset during or subsequent to the expected lease contract?
If NO, use the “Derecognition Approach”
If YES, use the “Performance Obligation Approach”
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Lessor Accounting – Derecognition Approach
Leased asset is removed from the books (treated like a sale, term is “lease expense” instead of COGS).
Receivable is booked for the “right to receive lease payments”.
Recognizes the bulk of revenue up front, with interest income recorded on the subsequent cash payments.
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Lessor Accounting – Performance Obligation Approach
Leased asset stays on books (and depreciated as usual).
Receivable is booked for the “right to receive lease payments”.
Liability (unearned revenue) is booked for the corresponding “lease liability”.
The unearned revenue is recognized over time (likely straight-line basis). Term to be used is “lease income”.
Interest income is recognized on the receivable.
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Transition
“Simplified Retrospective Method”
Determine all remaining lease payments as of date of implementation, discount, and record the corresponding asset and liability.
Implementation Date
Nothing definite yet, perhaps 2013 or later for nonpublic entities?
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Good Luck!
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