[Podcast] Time to prepare... for lease accounting changes


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The lease accounting changes will have a significant impact on your business - from finance to operations to technology! Don’t wait to begin the planning process. Learn from a panel of real estate and accounting experts in a discussion on the key aspects of the revised accounting requirements and their impact on your bottom line.

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[Podcast] Time to prepare... for lease accounting changes

  1. 1. Time to prepare !…for lease accounting changes
  2. 2. Erik LangePartnerAccounting AdvisoryServicesKPMGMindy BermanManaging DirectorCapital MarketsJones Lang LaSalleVivian MumawInternational DirectorGlobal Lease AdministrationJones Lang LaSalleToday’s guests2
  3. 3. Proposed changes3
  4. 4. Goal• Recognize off-balance sheet obligations• Create economic transparency* Estimate according to the 2005 SEC report on off-balance sheet activities$1.25 trillion of off-balance sheet operating lease commitments for SEC registrants*$1,250,000,000,00044
  5. 5. Greater transparencyabout leverage, assetsused in operations,and cash flowsGreater transparencyabout residual valuesOverviewMost lease assets andliabilities are off-balance sheetLesseeLesseeLessorExistingaccounting issuesTheproposalHow the proposalis an improvementRecognition of leaseassets and liabilitiesfor all leases of morethan 12 monthsInsufficientdisclosure aboutoperating leasesEnhanced disclosurerequirementsLack of transparencyabout residual values ofequipment and vehiclesSeparately account forresidual assetEnhanced disclosuresabout residual asset’sexposure to risk55
  6. 6. Anticipated timeline2013 2015 2016Final standardexpected to beissued in 2014Two yearlook-backperiodRevised exposuredraft publishedMay 16, 2013Commentletters dueSept 13, 20131 2 3 4 5Effective date ofnew standard:2017 / 20182014 201766
  7. 7. Proposed right-of-use model77A lease contract conveysthe right to use anunderlying asset fora period of time in exchangefor considerationLessorLessee
  8. 8. Scope• All existing leases – no grandfathering- Operating leases and capital leases• All enterprises – public, private, not-for-profit• All leases – real estate, equipment, leases embedded in servicecontracts- Regardless of underlying asset location• Short-term leases exempted- 12 months or less, including renewal/extension options88
  9. 9. Lease classification99LeaseTerm:PV of Fixed Lease PaymentsAmortization and Interest expenseAccelerated expense profileLease expenseStraight-lined over termType ANon-propertyType BPropertyLow HighHighEconomicLifeofAssetFair Value of Asset:• Definition looks to consumptionof underlying asset• Test performed at leasecommencement or modification
  10. 10. Summary of changes – lessee accountingCurrent Operating Lease Model Proposed Lease ModelBalance Sheet Off balance sheet Recognize right-of-use asset and liabilityIncomeStatementRent expense • Type A: Non-property leases– Interest and amortization expense• Type B: Property leases– Straight line lease expenseLease Term Non-cancellable term unless significanteconomic penalties for failure to renew• Options to extend & terminate included if lesseehas significant economic incentive to exercise• Reassessment requiredVariableLeasePaymentsNo contingent rent included • Contingent rent based on an index or rate (i.e.CPI) using spot rate – no forward or forecastedrates used• Performance or usage based rents excludedPurchaseOptionsBargain purchase option prohibited Included if lessee has significant economic incentiveto exerciseShort TermLeases• No liability / asset recognized• Rent expense• No liability / asset recognized• Rent expenseImpairment No testing required Testing and recognition required1010
  11. 11. Lease term1111• The existence of atermination option• Contingent amounts dueunder residual valueguarantees= Re-assessed periodically*SignificantEconomicIncentive• The importance ofthe leased asset tothe lessee’soperations• Economic penaltiessuch as significantcustomization,installation costs orrelocation costs• The existence of apurchase option orlease renewaloption and therelated pricingContract AssetEntity MarketNon-cancelablelease period+Lease extension options(w/ SEI* to exercise)+Lease termination options(w/ SEI* NOT to exercise)= Lease Term
  12. 12. Discount orIncrementalBorrowing RateRight of UseAsset / Liability@ inceptionInitial measurement of expected lease paymentsPresent Value:Apply:Contingent RentBased on Rate or IndexRent PaymentsNon-cancellable termFV of ResidualValue GuaranteesTerm PenaltiesSEI to ExerciseInitial IndirectCostsRenewal PeriodSEI to ExerciseDecommissioningCostsInclude: Exclude:LeaseIncentivesPerformance /Usage RentOperatingExpenseCapitalized lease obligations+ – × =1212
  13. 13. 1313Effect on accounting300,000350,000400,000450,000500,000550,000600,000650,0001 2 3 4 5 6 7AnnualExpense($)Year* The above graph represents a 7 year office space lease with an option to renew for 3 years. The annual base rent is $500,000 escalating at 3%annually. The tenant does not have a significant economic incentive to exercise the renewal option.Cash Rents Lease PaymentsType B Income Statement:Straight-lined leaseexpenseType A Income Statement:Interest and amortizationexpense
  14. 14. Receivable and Residual Model• Lease is the sale of a more thaninsignificant portion of the underlying asset• Recognize profit upfront on receivableportion, if anyType A – Non-property Leases Type B – Property LeasesFinancing Receivable Residual InterestNo receivable orresidual recognizedPP&EOperating Lease ModelReceivable and Residual ModelOperating Lease Model• Lease is the service of providing accessto an underlying asset for a stated periodof time• Income recognition similar to current U.S.GAAP• No fair value accounting for propertycompaniesLessor accounting1414
  15. 15. Other lease arrangementsNew ApproachSubleases • Recognize primary lease obligation• Account for sublease arrangement separately• Present on net basisSale-leasebacks • Determine if financing or sale• Immediate gain recognition for sale• Purchase options at market acceptableBuild-to-suits • Accounting based on lease classification• Principles-based tests1515
  16. 16. Disclosure requirementsThe new standard is expected to require the accumulation of additional data pointsand assumptions, which include but are not limited to:• Payment amount considering lease term, including the significant economicincentive to exercise:- Renewal options- Purchase options- Termination options• Discount rate• Commencement date• Residual value guarantee• Embedded operating costs (e.g., service, CAM, utilities, taxes, insurance, etc.)• Maximum possible term (including renewal options) less than 12 months• Determination of individual lease classification between the straight line leaseexpense and interest and amortization expense methods1616
  17. 17. Business impact17
  18. 18. Organizational impact18
  19. 19. 1919Increase in P&L burden,accelerated expense forcertain leasesDifferent accounting ofsimilar leasesChange in lease vs. owndecision-makingChange in expenseallocation to businessunitsPotential violation offinancial covenantsIncrease in financialreporting burdenSubstantial increase inliabilities on the balancesheetChange in desired leaseterms and structureNo expected change incredit ratingsImplications for corporate occupiers
  20. 20. Industry specific impact2020FinancialServicesHealthcareGovernmentContractorsTelecomRetail
  21. 21. Transaction strategies – myths and realitiesOwn vs. lease decision-makingOwn instead of lease • Use of corporate capital• Ability to control or own certain property• Operating flexibility• Economic vs. accounting-based decisionsMinimize or avoid capitalizationUse shorter lease terms • Commercial feasibility and economic terms• Short-term lease exemption – principles-based standard• Termination options – principles-based standardLimit / eliminate renewal options • Evaluated through lens of significant economic incentive• Commercial feasibilityCreative rent structures • Usage or percentage of sales-based rentsCreative lease structures • Use of purchase options and residual value guarantees2121
  22. 22. Get prepared22
  23. 23. Key StepsStrategyModify lease terms lFinancing arrangementsOperationsDefine roles l Develop processes lModify BU metrics l Align resourcesTechnology / DataCollect data for D1 impact l Review / modify technology lAssess impact l Design reporting2017+Maintain2014ImplementNowPlan23
  24. 24. Technology and dataData Tracking Reporting AccountingCurrent • Lease terms, options,rent schedule• Deposits, allowances• Conditions re. RVG,option penalties,decommissioning, BPO• Fixed term leaseobligation• Rent roll / income• Future critical dates• Abstract summaries• Rent expense,income• Cash receipts• Budget• Straight-line rentsAdditionalRequirements• Direct costs• IBR / Discount Rate• Value estimates(economic life, assetvalue, exit costs, RV)• Economic incentivefactors• Assets and obligations• Amortization schedules• Reassessment support• Expanded portfolio data• Asset and obligationsfor balance sheet• Amortization usingestimated life• Financing costs• Reassessment impact2424
  25. 25. Calculate/anticipate impact of changesEstablish cross-functional teams/processesFacilitate strategic/tactical decision supportLease Portfolio (real estate and equipment)Action PlanStaffing LevelsChange ManagementCommunications, TrainingGovernance FrameworkBusiness Assumptions,Work Routines and ProcessesInformation SystemsData Collection/Management,ReportingIdentify data/resource gapsInformation SystemsHuman ResourcesLease InformationOrganizationPositioning your lease portfolio2525
  26. 26. What should I do now?• Get educated and stay informed!- Visit www.leaseaccountingchanges.com togain access to educational materials andstay abreast of on-going developments• Get vocal!- Submit comments by September 13, 2013 viaFASB/IASB website2626• Get prepared!- Understand the impact of the changes on your organization- Advise your internal stakeholders- Plan for change
  27. 27. For more information2727Michael BillingExecutive Vice PresidentStrategic ConsultingJones Lang LaSallemichael.billing@am.jll.com+1 312 228 2638Erik LangePartnerAccounting AdvisoryServicesKPMGelange@kpmg.com+1 212 872 6654Mindy BermanManaging DirectorCapital MarketsJones Lang LaSallemindy.berman@am.jll.com+1 617 316 6539Vivian MumawInternational DirectorGlobal LeaseAdministrationJones Lang LaSallevivian.mumaw@am.jll.com+1 312 228 2878