NEW LEASING PROPOSALS

PRESENTED BYJOHN C. FUSCO JR. CPA, MT

MACE MARCH 15, 2012

WITH APOLOGIES TO BOB DYLAN

COME GATHER ‘ROUND ACCOUNTANTSWHEREVER YOU MAY ROAM

AND ADMIT THAT THERULES YOU WORK WITH

HAVE

GROWN

AND ACCEPT IT THAT SOONYOU’LL BE OVERLOADED WITH NEW STANDARDS

THAT CHANGE EVERYTHING YOU HAVE KNOWN

SO

IF YOUR TIME TO YOUIS WORTH

SAVIN’THEN YOU BETTER START

SWIMMIN’WITH THE TIDE

OR

YOU’LL SINK LIKE A STONEFORTHE

TIMESTHEY ARE

A-CHANGIN’

WHY?

BECAUSE THE ECONOMIST

HAVE WON THE FIGHTAND ARE DICTATINGWHAT ACCOUNTING

WILL REPORT

WE FOUGHT A GOOD FIGHT

BUT WE LOST THE BATTLE

SO NOW WE HAVE TO DEAL WITH INFORMATION THAT MAY

• HAVE QUESTIONABLE RELIABILITY• BE DIFFICULT TO VERIFY AT BEST• CLOUDS THE COMPARABILITY OF FINANCIALS

FROM YEAR TO YEAR AND COMPANY TO COMPANYALL THE THINGS WE CONSIDERED VITAL TO PRODUCING ACCURATE AND COMPARABLE

FINANCIAL STATEMENTS

NEW LEASING PROPOSALS

LET’S TAKE A LOOK AT WHAT IS PROPOSED AND VERY LIKELY TO HAPPEN TO LEASING RULES.

PRESENTLY WE HAVE CAPITAL AND OPERATINGLEASES FOR LESSEESWE HAVE SALES OR FINANCING TYPE LEASES

FOR LESSORSWE HAVE CONCRETE RULES TO DETERMINE

WHERE EACH LEASE FITS.

FASB AND IASB SAY PRESENT MODEL IS NOT ADEQUATE

• Fail to meet the needs of users of financial statements because they do not provide a faithful representation of leasing transactions

• Omit relevant information about rights and obligations that meet the definition of assets and liabilities in the boards’ conceptual framework

• Lead to lack of comparability and undue complexity

CURENT MODEL RESULTS IN

• Many Users adjusting amounts on the financial statements to reflect assets and liabilities arising from operating leases.

THEREFOREThe FASB and IASB initiated a joint project to develop a new approach to lease accounting that would ensure that assets and liabilities arising under leases are recognized in the statement of financial position.

CONCEPTS ARE NOT NEW

There has been a movement for quite some time pushing for accountants to report more assets, mostly intangible, and liabilities on the books.The DOT.COM bubble of the mid-nineties to 2000 was a prime example.The DOT.COMs said we accountants didn’t report their “valuable” assets.

THE LEASING ARGUMENT GOES WAY BACK TO THE EARLY 1970’S

• SEC Released in 1972 that took a Property Rights view of leasing.

• Leases conveyed a Right to the Lessee• Rights should be recorded as assets• ASR 147 stopped short of requiring the

recording of a rights asset and liability• Footnote disclosure of such rights was

required

THE CURRENT MOVEMENT

IN 2005 the SEC again started looking at how certain industries were interpreting SFAS 13 and related pronouncements of FASB.This cause over 360 restatements of financial statements in the retail and restaurant industry.

SONOT TO BE OUTDONE BY THE SEC

FASB AND IASB TOOK ON LEASING AS A PROJECT OF THE BOARDS IN 2006

RESULTS SO FAR

• Preliminary views discussion paper was issued in March, 2009, with comments due by July 17, 2009

• They were confused as to how to handle lessor accounting and at one point suggested not changing Lessor accounting!

• An Exposure Draft (ED) was issued August 17, 2010 with comment period until December 15, 2010.

• The boards received over 750 comments on the exposure draft. Comments ranged from complete dismissal of the concepts on the exposure draft to long detail discussion of the issues.

• The boards realized there were many areas of the initial exposure draft that were flawed.

• They then undertook to obtain input on what the problems were and what the solutions might work.

Since the comment period expired the boards have solicited input from preparers and investors with a vested interest in financial reporting. They did this by:• Having roundtable meetings around the world.• 15 preparer workshops attended by members of

the board• Solicited input via a preparer questionnaire and

an investor questionnaire

In addition the boards have been meeting almost every month for “redeliberations” on the issues.Where are we now?The goal is to have a reexposure draft out in the second half of 2012! Fully six years after starting the process!So we know some of the basics, have solved some of the really bad aspects of the original ED BUT all the decisions reached in the monthly meetings are listed as tentative decisions.

LESSEE ACCOUNTING

The concept of an “operating lease” is basically eliminated with one small exception.Since a lease conveys rights to the lessee, that is, the right to use the premises or equipment for a period of time in return for payment of the rental amounts, the Lessee will report a “Right of Use” asset on its books, along with a liability for the Lease Obligation.

Initial Measurement– At date of inception of lease, lessee shall measure:• Liability to make lease payments at present value of

lease payments, discounted using the lessee’s incremental borrowing rate, or, if it can be readily determined, rate lessor charges lessee• Right-of-use asset at amount of liability to make lease

payments, plus any initial direct costs incurred by lessee

Subsequent Measurement• After commencement of lease, lessee shall: –Measure liability to make lease payments

at amortized cost using interest method –Measure right-of-use asset at amortized

cost

EXAMPLES

3 YEAR COPIER LEASE $400/MONTHOPERATING LEASE UNDER CURRENT RULESTWO COMPANIESCOMPANY J AND COMPANY SAME LEASE TERMS/ SAME EQUIPMENT/ FROM THE SAME LESSORRESULTRENT EXPENSE $4,800/YEAR FOR THREE YEARSFOR BOTH COMPANIES

AMORTIZING THE RIGHT OF USE ASSET

• The original ED indicated that the lessee would amortize on a systematic basis that reflect the pattern of consumption of expected future economic benefits for those leases that effectively transfer all the risks and rewards of ownership of the underlying asset to the lessee.

• For those leases that do not transfer such risks and rewards use an approach that results in recognizing total lease expense in a pattern resembling current operating lease accounting.

IASB AND AMORTIZATION

IASB would take the approach where the right if use asset is amortized based on the estimated consumption of the underlying asset over the lease term. Thereby, higher the consumption rate the more the income statement effects would resemble purchasing the underlying asset and financing it separately. The lower the consumption rate the more it would resemble the current operating lease pattern.

NEW METHODYEAR COMPANY J COMPANY F COMPANY J COMPANY F

ASSET ASSET LIABILITY LIABILITY

INITIAL 13,148 12,765 13,148 12,765

1 8,766 8,510 9,025 8,844

2 4,383 4,255 4,648 4,598

3 0 0 0 0

INCOME STATEMENT EFFECTYEAR CO. J CO. F CO. J CO. F CO. J CO. F

INTEREST INTEREST AMORT AMORT TOTAL TOTAL

1 677 880 4,383 4,255 5,061 5,134

2 422 554 4,383 4,255 4,805 4,809

3 152 202 4,383 4,255 4,535 4,457

TOTAL 1,251 1,636 13,148 12,765 14,400 14,400

OFFICE RENTAL EXAMPLE

OFFICE RENTAL CONTRACT 5 YEARS (60 MONTHS), VARIABLE RATES, SIX MONTH RENT HOLIDAY TO BEGIN, DETAILS AS FOLLOWS:MONTHS 1-6 NO RENTMONTHS 7-12 $1,200/MONTHMONTHS 13-24 $1,500/MONTHMONTHS 25-36 $1,700/MONTHMONTHS 37-60 $2,000/MONTH

CURRENT ACCOUNTING

WE WOULD STRAIGHT LINE THE RENT OVER THE 60 MONTHS AND RECORD RENT EXPENSE EQUALLY PER YEAR OVE RTHE 5 YEARS.TOTAL RENT $93,600PER MONTH $ 1,560PER YEAR $18,720FOOTNOTE THE CASDH FLOWS PER YEAR FOR THE FOUR YEARS WHICH STILL HAS TO BE DONE.

NEW METHODOLOGYYEAR COMPANY J COMPANY F COMPANY J COMPANY F

ASSET ASSET LIABILITY LIABILITY

INITIAL 78,516 74,158 78,516 74,158

1 62,813 59,326 76,068 72,991

2 52,344 49,438 62,256 60,375

3 31,406 29,663 45,126 44,221

4 15,703 14,832 23,238 22,992

5 0 0 0 0

INCOME STATEMENT EFFECTYEAR CO. J CO. F CO. J CO. F CO. J CO. F

INT 6% INT 8% AMORT AMORT TOTAL TOTAL

1 4,752 6,043 15,703 14,832 20,457 20,865

2 4,188 5,383 15,703 14,832 19,891 20,215

3 3,269 4,246 15,703 14,832 18,972 19,078

4 2,112 2,770 15,703 14,832 17,815 17,602

5 762 1,008 15,704 14,832 16,465 15,840

TOTAL 15,083 19,441 78,516 74,160 93,600 93,600

LESSOR ACCOUNTING

The original ED suggested two methods for lessor accounting:• Derecognition approach and• Performance obligation approach.These were scrapped in the interest of accountants’ sanity. Replaced with what is being called the

“receivable and residual” approach

RECEIVABLE AND RESIDUAL

1. Lessor would initially measure the right to receive lease payments at the present value of the lease payments using the rate the lessor charges the lessee

2. Residual asset = an allocation of the carrying amount of the underlying asset. Initial measurement has two parts:

1. Gross residual asset measured at the PV of the estimated residual value at the end of the lease term discount using the rate as above.

2. Deferred profit, measured as the difference between gross residual asset and the allocation of the carrying amount of the underlying asset.

RECEIVABLE AND RESIDUAL (con’t)

3. Subsequently measure gross residual asset by accreting to the estimated residual value at the end of the lease term using the rate the lessor charges the lessee. Deferred profit would not be recognized until the residual asset is sold or released.

4. Present the gross residual asset and the deferred profit together as a net residual asset.

SUBLEASES

If you as lessee sublease equipment or property to another you step into the shoes of a lessor. This would be accounted for as lessors account for leases. Your lease (the head lease)and the sublease are accounted for as separate transactions. The initial lease (head lease) is accounted for under the methods used as lessee.The intermediate lessor (original lessee) should evaluate its right of use asset to determine appropriate lessor accounting not the underlying asset.

LESSEE DISCLOSURE

1. Reconciliation of opening and closing right of use assets by class of underlying assets.

2. Reconciliation of opening and closing balance of the obligation to make lease payments.

3. Maturity analysis of undiscounted cash flows included in the liability for first five years and thereafter.

4. Tabular analysis of all expenses incurred for leases.

ADDIITONAL LESSEE DISCLOSURE

1. Present or disclose separately interest expense and interest paid relating to leases.

2. Not combine interest and amortization and present as lease or rent expense.

3. Disclose the future contractual commitments associated with services and other nonlease components that are separated from a lease contract.

SURPRISE!

DON’T HAVE TO DISCLOSE:• Discount rate used to calculate liability to

make lease payments• Range of discount rates use dto calculate

liability to make lease payments• Fair value of liability to make lease payments• Terms of options to purchase the underlying

asset nor initial direct costs incurred.

LESSOR DISCLOSURE

• Breakdown of all income from lease related activities by type in tabular form

• Basis and terms of variable lease payments• Information or options to purchase or renew

leases• Reconciliation of opening and closing balance

of right to receive lease payments and residual assets

LESSOR DISCLOSURE (con’t)

• Maturity analysis of undiscounted cash flows in right to receive lease payments, five years and thereafter.

• Residual asset risk and value guarenteesNOT REQUIRE TO DISVLOSE• Initial direct costs• Rang eof discount rates used• Fair value of right ot receive lease payments

STATEMENT OF CASH FLOWS

• Cash paid related to principal within financing activities

• Cash paid related to interest as other interest is classified

• Cash paid for variable lease payments not in the liability as operating

• Cash paid for short term lease as operating

PROBLEMS CREATED

• Everybody has leases• Transition• Systems• Metrics