the fasb's new leases standar: a closer look - united …file/ey... · practical expedient...

The FASB’s new leases standard: a closer look

27 September 2016

Today’s moderator

Meredith

Lloyd

Executive Director

Professional Practice Group

Ernst & Young LLP

27 September 2016 The FASB's new leases standard: a closer look

Today’s agenda

► Overview, scope and definition of a lease

► Identifying and separating lease and non-lease

components of contracts

► Lease classification

► Lessee and lessor accounting

► Sale and leaseback transactions

► Transition to the new standard


Today’s panelists


Jeremy SimonsPartner, Ernst & Young LLP

Mark MaharPartner, Ernst & Young LLP

Robert Harrison Senior Vice President

Chief Accounting Officer and Controller

Target Corporation

The information contained herein is a summary in nature. Viewers should consult their own professional

advisors to address their individual circumstances and concerns.

Polling question

Which of the following best

describes the status of your

organization’s implementation

activities?

A. We are gaining an understanding of the new standard

B. We have assembled a cross-functional project team to develop an implementation plan

C. We have a cross-functional project team that has begun executing on an implementation plan

D. Does not apply (EY professional, faculty, other)


Overview, scope and definition of a lease


OverviewRight-of-use model

► Recognize right-of-use (ROU)

assets and lease liabilities for

most leases

► Recognize expense similar to

legacy GAAP

Right to use an identified asset

Lessor

OperatingFinance

Financial obligation to make

lease paymentsLessee


► Similar to legacy GAAP with

some changes

► Leveraged lease accounting

eliminated prospectively

Direct

financing

Sales-

typeOperating

Lease classificationLease classification

OverviewEffective date and transition

Prior periods presented

SAB Topic 11.M

2021201920182016

Effective

Public

entities*

2017

Early adoption

permitted

All other entities

2020

Prior periods presented

* Public entities include public business entities and certain not-for-profit entities and

employee benefit plans.

► The transition provisions are applied using a modified retrospective

approach

► Full retrospective adoption is prohibited


Scope and definition of a lease Overview

► The standard applies to leases of property, plant and equipment

► It does NOT apply to:

► Leases of inventory, assets under construction, intangible assets and

biological assets, including timber

► Leases to explore for or use minerals, oil, natural gas and similar

non-regenerative resources


A lease is a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment (an identified asset) for a period of time in exchange for consideration.

Scope and definition of a leaseApplying the definition of a lease – what is changing?


Legacy GAAP

► Any one of the following criteria is met:

► The customer operates the PP&E

► The customer controls physical

access to the PP&E

► It is remote that other parties will take

more than a minor amount of the

output, and certain pricing criteria are

met

The new leases standard

► The customer has both:

► The right to substantially all the

economic benefits from the use of

the identified asset throughout the

period of use

► The right to direct how and for

what purpose the asset is used

throughout the period of use

► Guidance says that there is no

identified asset if the supplier has a

substantive substitution right

► Guidance does not address

substitution rights

An asset is identified explicitly or implicitly

The customer has the right to control the use of the identified asset

Scope and definition of a lease Example: fact pattern

► A utility company (Customer) enters into a

contract with a power company (Supplier)

to purchase all of the electricity produced

by its wind farm for 20 years and

available renewable energy credits

► Supplier designed and constructed

the wind farm

► Supplier has no substitution right

► Customer cannot determine or change the amount of output during

the contract

► Customer will pay a fixed capacity charge and a variable charge

based on actual production

► Supplier operates and maintains the wind farm and retains certain

rights to protect its interest in the wind farm


Contract does not contain a leaseContract contains a lease

Legacy GAAP

► It is remote that another party will take

more than a minor amount of the

facility’s output, and the price that

Customer will pay meets certain criteria


► Customer has the right to obtain

substantially all the economic benefits

from the use of the wind farm

An asset is identified explicitly

Scope and definition of a lease Example: analysis and conclusion


Customer does not have theright to control the use of the

identified asset

27 September 2016

Customer has the right to control the use of the

identified asset

► Customer does not have the right to

direct how and for what purpose the

wind farm is used

► Does the entity use a standard lease/service contract, or do the form and content vary?

► Does the entity operate in a decentralized or centralized environment?

► What type of arrangements does an entity have that could be affected by the revised definition of a lease?

► How does an entity plan to identify any necessary changes?

► Will management be required to make more judgments when evaluating contracts?

… verify the

completeness of

their portfolio of

leases

Entities need internal processes, controls and systems in place to…

… evaluate whether

a contract is or

contains a lease

Scope and definition of a leasePractical considerations


Identifying and separating lease and non-lease components of contracts



► The right to use each asset is considered a separate lease

component if both of the following criteria are met:

► The right to use land is generally accounted for as a separate lease

component

► Non-lease components (e.g., services) are identified and accounted

for separately from the lease component under other US GAAP

► Practical expedient – lessees


The lessee can benefit from

the right of use either on its

own or together with other

resources that are readily

available

The right of use is neither

highly dependent on, nor

highly interrelated with, the

other right(s) to use underlying

assets in the contract

1 2


Insurance, taxes and maintenance (including common area maintenance)

Legacy GAAP

► The term “executory costs” is

eliminated

► Payments for maintenance

activities are non-lease

components

► Payments for insurance that

protects the lessor’s interest in

the asset and taxes related to

the asset are not separate

components

► Payments for insurance,

maintenance and taxes

(executory costs), and any profit

thereon, are part of the lease

component but excluded from

minimum lease payments

► If not specified in the

agreement, such costs are

estimated




Lessees

Allocate consideration in the contract to the lease and non-lease components

► Generally apply the revenue

recognition guidance – relative

standalone selling price basis

► Carefully analyze variable

payments

► Relative standalone price basis

► Use observable standalone

prices when available

► Estimate standalone price if

not available, maximizing

observable information

► Residual estimation approach

may be appropriate in some

cases


Lessors

Polling question

Do you expect your

organization to early adopt

the guidance in the new

leases standard?

A. Yes, we plan to early adopt with

revenue recognition

B. Yes, we plan to early adopt

before revenue recognition

C. No

D. Not sure

E. Does not apply (EY professional,

faculty, other)


Lease classification


Lease classification criteria

► The lease transfers ownership of the underlying asset to the lessee

by the end of the lease term

► The lease grants the lessee an option to purchase the underlying

asset that the lessee is reasonably certain to exercise

► The lease term is for the major part of the remaining economic life

of the underlying asset

► The present value of the sum of the lease payments and any

residual value guaranteed by the lessee that is not already

reflected in the lease payments equals or exceeds substantially

all of the fair value of the underlying asset

► The underlying asset is of such a specialized nature that it is

expected to have no alternative use to the lessor at the end of

lease term



Lessees

► Leases that meet any one of the

criteria are finance leases

► Leases that do not meet any of

the criteria are operating leases

► Short-term lease exemption

► Lease term of 12 months or

less and no purchase option

that the lessee is reasonably

certain to exercise

► Accounting policy election, by

class of underlying asset

► Lease assets and liabilities not

recognized



Lessors

► Leases that meet any one of the

criteria are sales-type leases

► Leases that do not meet any of

the criteria are either:

► Direct financing leases if (1) the

present value of the sum of the

lease payments and any

residual value guaranteed by the

lessee and/or any other

unrelated third party equals or

exceeds substantially all the fair

value of the underlying asset

and (2) collectibility is probable

► Operating leases

Lessee and lessor accounting


Lessee and lessor accountingLessee recognition and measurement

Finance leases Operating leases

Initially measure the ROU asset and lease liability at the present value of the lease

payments to be made over the lease term

Subsequently accrete the lease liability

based on the interest method and reduce

the lease liability by the payments made

Subsequently measure the lease liability at

the present value of remaining lease

payments

Subsequently amortize the ROU asset,

generally on a straight-line basis over the

shorter of the lease term or the useful life

of the ROU asset

Subsequently measure the ROU asset at

the amount of the remeasured lease

liability, with certain adjustments

Generally “front-loaded” expense Generally straight-line expense


Lessees’ initial direct costs, prepayments made to the lessor and lease incentives

received from the lessor are accounted for as part of the ROU asset.

Operating leases

► Continue to recognize

underlying asset

► Recognize lease

payments as income

over the lease term,

generally on a straight-

line basis

Sales-type leases

► If collectibility is probable, derecognize underlying asset and recognize a net investment in the lease and selling profit (loss)

► If collectibility is not probable, recognize lease payments received as a deposit liability (i.e., do not derecognize underlying asset because sale is deferred)

Direct financing leases

► Derecognize underlying asset and recognize a net investment in the lease

► Defer selling profit and recognize over the lease term

► Recognize selling loss up front

Lessee and lessor accountingLessor recognition and measurement


► New disclosures for lessees include:

► Maturity analyses, including a reconciliation of undiscounted cash flows to

the lease liability, as of the reporting date

► Lease expense, by type (e.g., finance, operating, short-term)

► Weighted average remaining lease term, by lease type

► New disclosures for lessors include:

► Information about how they manage risks related to residual values of

leased assets

► For sales-type and direct financing leases, explanations of significant

changes in the balance of unguaranteed residual assets

► Table of lease income recognized during each annual and interim

reporting period

Lessee and lessor accounting Disclosure

The FASB's new leases standard: a closer look 27 September 2016

The new standard requires more disclosures for lessees and lessors.

Understand the

implications to financial

statements

Communicate changes to stakeholders

Lessee and lessor accountingPractical considerations


Understand the

implications to internal

IT systems, processes

and controls

Think about

implementing the new

standard as more than

a compliance exercise

Polling question

Which of the following activities do

you believe will be the most

challenging for your organization

when implementing the new leases

standard?

A. Identifying a complete population of leases

B. Implementing changes required to internal

IT applications, policies, processes and

controls

C. Educating stakeholders and others within

the organization

D. Not sure

E. Does not apply (EY professional, faculty,

other)


Sale and leaseback transactions

27 September 2016 The FASB's new leases standard; a closer look

Sale and leaseback transactions Overview

► Seller-lessees and buyer-lessors use the new revenue recognition

guidance to determine whether to account for the transfer of an asset

as a sale and purchase

► Existence of a leaseback, in isolation, does not preclude a sale

► Sale is precluded when either:

► Leaseback is classified as a finance lease (lessees) or a sales-type lease

(lessors)

► Seller-lessee has a substantive repurchase option

► If sale is precluded:

► Seller-lessee records a financing liability equal to proceeds received

► Buyer-lessor records a finance receivable equal to amounts paid

Sale and leaseback transactions no longer provide seller-lessees with a source

of off-balance sheet financing.


Sale and leaseback transactionsLessee involvement in asset construction (“build-to-suit”)

► The focus is whether the lessee controls the asset being constructed,

rather than whether the lessee has substantially all of the risks during

the construction period

Examples of when a lessee may be the deemed owner during construction


Legacy GAAP

► The lessee has the right to obtain the partially constructed underlying asset

► The lessor has an enforceable right to payment for its performance to date, and the asset does not have an alternative use to the owner-lessor

► The lessee legally owns the non-real estate asset under construction

► The lessee controls the land that the property improvements will be constructed upon

► The lessee provides certain

guarantees or indemnities

► The lessee is responsible for paying

any cost of the project directly (with

certain exceptions)

► The lessee is obligated to fund cost

overruns

► The lessee acts as a developer or is

the general contractor


Transition to the new standard

27 September 2016 The FASB's new leases standard; a closer look

Transition to the new standard Modified retrospective transition


The date of initial application The beginning of the earliest

comparative period presented

► Entities apply the transition provisions using a modified retrospective

transition approach to leases that:

► Exist at the date of initial application

► Commence in the comparative periods presented

► The transition provisions are applied at the later of the:

► Date of initial application

► Lease commencement date

► Full retrospective application is prohibited

► Do not reassess:► Whether contracts are or

contain leases

► Lease classification

► Whether initial direct

costs qualify for

capitalization

► Use hindsight when

determining the lease term

and assessing impairment

of ROU assets (lessees

only)

Transition to the new standardPractical expedients

► Lessees and lessors are permitted to make an election to apply the

package of practical expedients and/or the hindsight practical

expedient


Package of expedients Hindsight expedient

► If elected, practical expedients must be applied to all leases

Transition to the new standard Lessees


Operating under legacy GAAP –

finance under the new standard

Initially and subsequently measure:

► The lease liability based on

remaining minimum rental

payments under legacy GAAP

and any amount that a lessee is

probable of owing under a

residual value guarantee

► The ROU asset as the applicable

portion of the lease liability, with

certain adjustments

Operating under legacy GAAP –

operating under the new standard

Initially and subsequently measure:

► The lease liability based on

remaining minimum rental

payments under legacy GAAP

and any amount that a lessee is

probable of owing under a

residual value guarantee

► The ROU asset at the amount

equal to the lease liability, with

certain adjustments

Transition to the new standard Lessees


Capital under legacy GAAP –

finance under the new standard

► Generally apply legacy GAAP in

the comparative periods

presented

► Generally apply the subsequent

measurement guidance in the

new standard beginning on the

effective date

► Derecognize carrying amount of

capital lease assets and liabilities

in the comparative periods

presented

► Apply the initial and subsequent

recognition and measurement

guidance in the new standard in

all periods presented

Capital under legacy GAAP –

operating under the new standard

A lessee no longer applies the modified retrospective transition approach upon

certain lease modifications and the remeasurement of lease liabilities on or

after the effective date.

Transition to the new standard Lessors

► If lease classification does not change:

► Generally apply legacy GAAP

► For certain lease modifications on or after the effective date, apply the new

standard

► If lease classification changes:

► Generally derecognize the carrying amount of the existing asset (i.e., PP&E

or the net investment in the lease)

► Generally account for the lease under the new standard

► Leveraged leases that commenced prior to the effective date are

grandfathered

► If a leveraged lease is modified on or after the effective date, it is accounted

for as a new lease


Sales-type Direct financing Operating

Transition to the new standardWhat makes it complex?

1Modified retrospective transition – There are many specifictransition requirements and practical expedients to consider.

2IT systems, processes and controls – Implementation will likely require new IT applications, process and controls.

3Resource allocation – Management will want to make sure it hassufficient resources for implementation.


4Judgments and estimates – The new standard will likely require more judgments and estimates.

Interaction with other guidance – Understanding the interaction of the new leases standard with the new revenue recognition standard will be key to successful implementation for lessors.

5

Thank you!

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