Lease Accounting FAS 13 Intro Course for CFO
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Complimentary Course for Financial Executives on Implications of New Lease Accounting Changes on Corporate Real Estate

Complimentary Course for Financial Executives on Implications of New Lease Accounting Changes on Corporate Real Estate

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  • (c) 2002 David Worrell To contact David Worrell please email him at [email_address] or visit his website www.ccgiweb.com
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Lease Accounting FAS 13 Intro Course for CFO Presentation Transcript

  • 1. Corporate Real Estate & IAS 17 An analysis of the impact of corporate real estate on the corporate financial statements under IAS 17 © 2011 Cambridge Consulting Group Inc.
  • 2. Course Introduction
    • Outline of the course materials
    • Methodology of instruction
    • Instructor introduction: David Worrell, MCRS.h, CAS Managing D irector, Cambridge Consulting Group
      • Administrative issues
    © 2011 Cambridge Consulting Group Inc.
  • 3. Table of Contents
    • Introduction to IAS 17
    • Review of Managerial Finance
    • The Financial Statements
    • The Financial Ratios
    • Lease Accounting: Operating and Capitalized
    • The Effects of IAS 17
    • Communicating with Senior Management
    • Summary
    © 2011 Cambridge Consulting Group Inc.
  • 4. Course Objectives
    • Define corporate financial structure and goals
    • Define the purpose of the corporate financial statements
    • Define the three principal financial statements
    • Define basic financial ratios and describe their uses
    • Define the differences in operating and capital leases
    • Define how leases will be accounted for in the future
    • Describe a format for communicating the financial impacts of a real estate strategy
    © 2011 Cambridge Consulting Group Inc.
  • 5. Introduction to Finance
    • Finance covers financial analysis and planning, investment decisions, financing and capital structure decisions, and management of financial resources
    • The goals of managerial finance are:
      • Stockholder wealth maximization
      • Profit maximization
      • Managerial reward maximization
      • Behavioral goals
      • Social responsibility
    © 2011 Cambridge Consulting Group Inc.
  • 6. Managerial Finance
    • Primary long term goal: the maximization of stockholder wealth
    • Primary short term goal: the maximization of profits
    • The primary members of the finance department are:
      • The Chief Financial Officer
        • Supervises all phases of financial activity and serves as financial advisor to the board of directors
      • The Treasurer
        • Handles external financial matters and is responsible for managing corporate assets and liabilities, financial planning, capital budgeting and managing any investment portfolios
      • The Controller
        • Handles internal financial matters such as financial cost accounting, taxes, budgeting, and control functions
    © 2011 Cambridge Consulting Group Inc.
  • 7. Foundational Principles Review
    • GAAP & FASB
    • Measurements of Resources
    • Accounting Equation
    • Accrual Principle
    • Materiality
    • Substance vs. Form
    • Operating and Capitalized Leases
    • Depreciation
    © 2011 Cambridge Consulting Group Inc.
  • 8. GAAP – FASB - IASB
    • GAAP is the acronym for Generally Accepted Accounting Principles
    • G AAP is a set of guidelines and procedures that constitute acceptable accounting practice at a given time
    • FASB is the acronym for Financial Accounting Standards Board
    • IASB is an acronym for the International Accounting Standards Board
    • Financial accounting requirements are announced by the financial accounting standards board (FASB) which is the principal rule making body of the accounting profession
    © 2011 Cambridge Consulting Group Inc.
  • 9. What is IAS 17?
    • The IASB is the International Accounting Standards Board, the international equivalent of our Federal Accounting Standards Board (FASB).
    • The U.S. is moving towards merging all accounting standards to a joint international standard.
    • IAS 17 is an attempt by the international accounting standards groups to make leasing activities more transparent to a corporation and their stakeholders.
    5 © 2011 Cambridge Consulting Group Inc.
  • 10. Why the Change to IAS 17?
    •  Presently, the public only sees what is above the water
    •  IAS 17 shows the public what is below the water
    © 2011 Cambridge Consulting Group Inc.
  • 11. Why the Change to IAS 17?
    • IAS 17 will make leasing (now financing) activities more transparent to the stakeholders of a corporation using large numbers of leases
    • Most corporations prefer to lease assets and real estate rather than purchase and own them
      • The most cited reasons are to preserve cash and maintain flexibility
      • Maintaining flexibility is critical where location, size and market timing are fluid
    • Just as important, under the old FASB regulations, leases were an income statement event only
      • There was no recordation of the obligation on the balance sheet (except as a footnote)
    © 2011 Cambridge Consulting Group Inc.
  • 12. Leases: Operating and Capital
    • Operating Leases:
      • An operating lease transfers certain rights to occupy a property while leaving the major risks and benefits of ownership with the Owner
      • The most notable characteristic of an operating lease is that your company does not record the financial liability on its balance sheet
      • An operating lease may be triple-net or full service
      • An operating lease is considered an expense
    © 2011 Cambridge Consulting Group Inc.
  • 13. Benefits of Operating Leases
    • It usually does not require a large outlay of company capital which leaves the company more liquid and flexible . The company can expense, and therefore write-off, the full rent payment
    • Financial Statements impacted:
      • The Income Statement
      • The Cash Flow Statement
    © 2011 Cambridge Consulting Group Inc.
  • 14. Capitalized Leases
    • A Capitalized Lease is a long-term lease which is treated, for accounting purposes as if it were a purchase
    • In Form , a capital lease is similar to an operating lease: rental payments are made, and the Owner still owns the property
    • In Substance , it is so much like a purchase, it is treated as such in that the lease conveys so much of the useful life and value of the property that the Lessee rather than the Lessor is receiving the benefits of ownership
    • Under a capital lease, rent payments are treated as mortgage payments and carried on the Balance Sheet as an Asset and Liability Under the New IAS 17 Regulation:
      • The Asset side of the recordation will be called a “Right to Use” asset
      • The Liability side of the recordation will be labeled an “Obligation to Pay”
    © 2011 Cambridge Consulting Group Inc.
  • 15. What will Happen?
    • IAS 17 will require every operating lease for your company to be converted to a capitalized status.
      • Operating Leases are an Income Statement Event Only
      • Capitalized Leases are Similar to Mortgages:
        • You Record an Asset and a Corresponding Liability
        • The Asset Will Be Called a “Right to Use”
        • The Liability Will Be Called an “Obligation to Pay”
    © 2011 Cambridge Consulting Group Inc.
  • 16. IAS 17 and Real Estate Leases
    • Implications of IAS 17 - What Will It Bring?
    • 10 and 5 Year Lease Examples
    • EBITA
    • Incremental Borrowing Rate
    • Surplus Properties – Subleases Under IAS 17
      • How It Was Up Until Now – No Exceptions
      • New Implications - Requirements
      • The New “Double Whammy”
      • What is “Mark to Market”
      • How Do I Manage This Now?
    © 2011 Cambridge Consulting Group Inc.
  • 17. The Capital Lease Test
    • A capital lease is effectively created if only one of the following four criteria are met:
      • The lease transfers ownership to the tenant at the end of the lease term
      • The lease contains a bargain purchase option
      • The length of the lease term is equal to or greater than 75% of the useful life of the property
      • The present value of the minimum lease payments, using the tenant’s incremental borrowing rate, less any tax credit, is 90% of the fair market value of the property at the beginning of the term
    © 2011 Cambridge Consulting Group Inc.
  • 18. 5 Year Lease Under IAS 17 © 2011 Cambridge Consulting Group Inc. Assumptions: 5 Year Lease, 10,000 SF, $14.40/PSF Annual, 7.5% Borrowing Rate Current Method New Method Rent Expense Depreciation Interest Total Difference % Diff. Year 1 144,000 120,521 40,227 160,748 16,748 12% Year 2 144,000 120,521 32,460 152,981 8,981 6% Year 3 144,000 120,521 24,112 144,633 633 0% Year 4 144,000 120,521 15,139 135,660 (8,340) -6% Year 5 144,000 120,521 5,455 125,976 (18,024) -13% Totals 720,000   602,607 117,393 720,000
  • 19. 10 Year Lease Under IAS 17 © 2011 Cambridge Consulting Group Inc. Assumptions: 10 Year Lease, 10,000 sf., $14.40/PSF Annual, 7.5% Borrowing Rate Current Method New Method Rent Expense Depreciation Interest Total Difference % Diff. Year 1 144,000 101,726 72,477 174,203 30,203 21% Year 2 144,000 101,726 67,033 168,759 24,759 17% Year 3 144,000 101,726 61,174 162,900 18,900 13% Year 4 144,000 101,726 54,869 156,595 12,595 9% Year 5 144,000 101,726 48,085 149,811 5,811 4% Year 6 144,000 101,726 40,783 142,509 (1,491) -1% Year 7 144,000 101,726 32,926 134,652 (9,348) -6% Year 8 144,000 101,726 24,471 126,197 (17,803) -12% Year 9 144,000 101,726 15,373 117,099 (26,901) -19% Year 10 144,000 101,726 5,553 107,279 (36,721) -26% Totals 1,440,000   1,017,260 422,744 1,440,000
  • 20. Operating vs. Capitalized Recognition 10 Year Lease © 2011 Cambridge Consulting Group Inc. Break-Even Date
  • 21. Surplus Leases Under IAS 17
    • How It Was:
    • The New Implications Requirements:
    • The “Double Whammy”
    • What Is “Mark To Market”?
    • How Do I Manage This Now?
    © 2011 Cambridge Consulting Group Inc.
  • 22. Surplus Leases Under IAS 17
    • How It Was:
      • Surplus Properties = Subleased Properties
      • Subleased Properties = Loss Reduction
        • No Balance Sheet Impact
        • Reduced Income Statement Impact
        • Major Pain To Accomplish
        • Cost Prohibitive
        • High Risk – Very Low Reward
    © 2011 Cambridge Consulting Group Inc.
  • 23. Surplus Leases Under IAS 17
    • How It Will Be (The New Requirements):
      • The Loss For Subleasing Will Remain with Some Bonuses:
        • You Will Now Also Carry the Sublease on the Balance Sheet Example: (From Previous Example) – Next Page
    © 2011 Cambridge Consulting Group Inc.
  • 24. Subleasing Under IAS 17 New Lease Basis A Sublease Increases the Lease Basis - An Additional Asset and Liability © 2011 Cambridge Consulting Group Inc.
  • 25. How Do I Manage Surplus Now?
    • Subleasing Surplus Space Will Become More Difficult and Less Advantageous Considering the Risk
      • Your Options?:
        • “ Go Dark” – Close the Facility. Reduces Operating Expenses Such as Utilities and Security.
        • Donate the Space to Charity. Landlords Normally Do Not Approve
        • Negotiate a Lease Termination – Not Easy But Far Less Expensive
          • Usually Can Be Done Around at 50 Percent of Remaining Rent.
          • Selling Management on This Option May Take Some Educating
    © 2011 Cambridge Consulting Group Inc.
  • 26. The Accounting Equation
    • Assets : The economic resources of the business
      • Assets that can be converted into cash inside one year are called current assets
    • Liabilities : The debts of the business
      • Those payable in one year are considered current liabilities
      • Those payable over a period of more than one year are classified as non-current liabilities
    • Capital (owner’s equity): The owner’s interest in the business
      • In a corporation, capital consists of two accounts: capital stock outstanding and retained earnings
    © 2011 Cambridge Consulting Group Inc.
  • 27. The Accounting Equation
    • The accounting equation states that assets must always equal creditor’s claims, liabilities and capital (owner’s equity)
    • The accounting equation is formally stated as: Assets = Liabilities + Capital + Profits (revenues - expenses) Double-entry accounting:
      • The accounting equation is the basis for double entry accounting, which means that every transaction has an effect on two or more accounts
    © 2011 Cambridge Consulting Group Inc.
  • 28. Measurement of Resources and Obligations
    • Resources are those things of value the business possesses and can use to produce a profit. The accounting term for resources is assets
    • Obligations, or liabilities , are amounts owed to non-owners of the business
    • The difference between assets and liabilities is the owner’s interest or equity in the business
    © 2011 Cambridge Consulting Group Inc.
  • 29. Balancing the Books Assets Liabilities Equity © 2011 Cambridge Consulting Group Inc.
  • 30. Accrual Principle
    • The accrual principle translates associated dollars of profit or loss to the actual activities of the period
      • The accrual principle provides that revenue be recorded when the activities to sell a good or service are completed
      • Costs directly associated with producing revenue will be expensed in the same period that the revenue is recorded
    © 2011 Cambridge Consulting Group Inc.
  • 31. Materiality
    • Materiality deals with relative importance
    • A transaction must be accounted for within the measurement and principles of GAAP when the amounts involved are judged to be material
      • Materiality answers the question: Could this item make a difference to the user of the financial statements?
      • What is a real estate example?
    © 2011 Cambridge Consulting Group Inc.
  • 32. Substance vs. Form
    • Accounting reports the economic substance of a transaction without regard to its form
      • An example would be a pledge to a charity. It is not a legally binding obligation, but the substance of the transaction is that the corporation intends to pay the pledge
      • The company has made a promise
      • The company’s reputation is at stake
      • What is a real estate example?
    © 2011 Cambridge Consulting Group Inc.
  • 33. Depreciation
    • Some assets are long-lived and help produce revenue over several periods, such as real estate
    • Depreciation (rather than amortization) refers to prorating a tangible asset’s cost
    • Accountants expense the cost of these types of assets over their expected, useful life
      • This is called DEPRECIATION
    • Some costs are expensed when they arise. These are costs that would not be expected to produce future sales such as utility expenses in an office building
    © 2011 Cambridge Consulting Group Inc.
  • 34. Depreciation Types
    • Straight Line : under the straight line method of depreciation, equal periodic charges for depreciation are made to income until the asset is fully depreciated Accelerated Methods :
    • Declining Balance : this method is an accelerated form of depreciation, which results in larger depreciation charges during the earlier years of an asset's life
    • Sum-of-the-year’s-digits : under this method, the years of the asset’s service life are added together. This sum becomes the denominator of a series of fractions, which is then applied to the cost of the asset less its salvage value
    © 2011 Cambridge Consulting Group Inc.
  • 35. Straight-Line versus Accelerated Depreciation How Net Asset Value Declines over Time Straight-Line Depreciation Accelerated Depreciation Time Net Asset Value © 2011 Cambridge Consulting Group Inc.
  • 36. The Financial Statements
    • What are the Financial Statements?
    • They are designed to satisfy the information needs of many different people:
        • Stockholders (and potential ones)
        • Creditors (and potential ones)
        • Analysts
        • Economists
        • Suppliers
        • Customers
    © 2011 Cambridge Consulting Group Inc.
  • 37. Is there enough money to pay me on time? Owners Current Employees Managers Suppliers Lenders Prospective Employees Attorneys and Litigants Customers Can they pay me back? Am I getting a return on my investment? Will they be in business tomorrow? Am I running the company efficiently? Is the company worth suing? Does this company have a future? Can the company afford to pay me more? Who Uses Financial Statements and What Do They Look For? © 2011 Cambridge Consulting Group Inc.
  • 38. What is an Annual Report?
    • The heart of the financial statements is the annual report
      • It must conform to accounting and reporting standards set by the FASB, SEC (if publicly traded) and committees of the AICPA
      • The part of the Annual Report controlled by Management includes:
        • Annual Report Highlights
        • A Letter to the Shareholders
        • A Review of Operations
    © 2011 Cambridge Consulting Group Inc.
  • 39. What is an Annual Report?
    • The Minimum Annual Report consists of 6 parts:
      • The Balance Sheet
      • The Income Statement
      • The Statement of Cash Flows
      • Accompanying Notes
      • The Auditor’s Opinion
      • Management’s Discussion
    © 2011 Cambridge Consulting Group Inc.
  • 40. The Balance Sheet
    • The balance sheet boldly declares where a organization stands at a provided moment in time
    • The principal reason the business balance sheet is so essential to you and to any potential traders or lenders is that it's like a photograph of the company
    • It tells how the enterprise is put together, what its principal resources are and where any potential dangers lie
    • It only shows one particular moment in time, and therefore is most beneficial in conjunction together with the revenue statement and by comparing a number of balance sheets over a time period.
    © 2011 Cambridge Consulting Group Inc.
  • 41. The Balance Sheet
    • It's called a balance sheet because the two sides balance out. This makes sense: a company has to pay for all the things it has ( assets ) by either borrowing money ( liabilities ) or getting it from shareholders ( shareholders' equity )
    • Each of the three segments of the balance sheet will have many accounts within it that document the value of each
    • Accounts such as cash, inventory and property are on the asset side of the balance sheet, while on the liability side there are accounts such as accounts payable or  long-term debt .
    © 2011 Cambridge Consulting Group Inc.
  • 42. Example of a Balance Sheet © 2011 Cambridge Consulting Group Inc.
  • 43. The Income Statement
    • The Income Statement (or Profit and Loss Statement) reports the results of business activities for a period of time (typically a fiscal year). These results are classified as Revenues and Expenses
    • Revenues measure the inflows of new assets into the business while expenses measure outflow and the using up of assets in the same process
    • Net income represents an increase in assets and owner’s equity while a net loss represents a decrease in assets and owner’s equity
    © 2011 Cambridge Consulting Group Inc.
  • 44. Income Statement Example © 2011 Cambridge Consulting Group Inc.
  • 45. The Statement of Cash Flows
    • The Statement of Cash Flows is like a bridge . It describes all of the changes that have occurred in the balance sheet during the fiscal year in terms of their effect on cash
    • Questions answered by Statement of Cash Flows:
      • Where did the earnings go?
      • Why was money borrowed?
      • How was the debt retired?
      • What happened to the proceeds of the bond?
    © 2011 Cambridge Consulting Group Inc.
  • 46. Cash Flow Statement Example © 2011 Cambridge Consulting Group Inc.
  • 47. Balance Sheet as of December 31, 2010 Balance Sheet as of December 31, 2011 Income Statement from January 2010 to December 31, 2011 FULL YEAR 2011 Cash Flow Statement from January 2010, to December 31, 2011 Relationship of Balance Sheet, Income Statement, and Cash Flow Statement © 2011 Cambridge Consulting Group Inc.
  • 48. The Financial Ratios
    • Ratio analysis is the basic technique used in the analysis of the financial statements
    • A ratio for a company can be compared to:
      • the company’s industry average
      • another company in the same industry
      • the same ratio for the company in prior years
    • Some of the most common ratios are:
      • Market Value Ratios
      • Profitability Ratios
      • Liquidity Ratios
    © 2011 Cambridge Consulting Group Inc.
  • 49. Market Value Ratios
    • Market value ratios apply to a company’s stock price relative to its earnings (or book value) per share, as well as dividend related ratios
    • Examples of these ratios are:
      • Earnings per Share
      • Price-Earnings Ratio
      • Book Value per Share
    © 2011 Cambridge Consulting Group Inc.
  • 50. Earnings Per Share
    • The amount of earnings per period for each common share held: EPS = Net Income - Preferred Dividends Number of Outstanding Shares
    © 2011 Cambridge Consulting Group Inc.
  • 51. Price-Earnings Ratio
    • The Price-Earnings Ratio (multiple):
    • Market price per share divided by earnings per share. A high P/E ratio indicates investor confidence in the company: P/E Ratio = Market price per Share Earnings per Share
    © 2011 Cambridge Consulting Group Inc.
  • 52. Book Value Per Share
    • Book Value per Share is the value of each share per the books based on historical cost
      • If market price per share substantially exceeds book value per share, it may indicate good stock market reception to the company
      • Stockholder’s Equity - Liquidation Value of Preferred Stock Outstanding Common Shares
    © 2011 Cambridge Consulting Group Inc.
  • 53. Profitability Ratios
    • Profitability Ratios reveals the company’s ability to earn a satisfactory return on investment. The ratios are an indication of good financial health and how effectively the company is managing its assets. Some examples of these ratios include:
      • Gross Profit Margin (GPM)
      • Return on Assets (ROA)
      • Return on Earnings (ROE)
      • Earnings Before Interest, Taxes & Amortization (EBITA)
    • Does Corporate Estate effect any of these ratios?
    © 2011 Cambridge Consulting Group Inc.
  • 54. Gross Profit Margin
    • The Gross Profit Margin reveals the percentage of each dollar earned left over after the cost of sales: GPM = Gross Profit Net Sales
    © 2011 Cambridge Consulting Group Inc.
  • 55. Return on Assets
    • Return on Assets indicates the efficiency with which management has used its resources to obtain income: ROA = Net Income Total Assets
    © 2011 Cambridge Consulting Group Inc.
  • 56. Return on Equity
    • Return on Equity measures the rate of return earned on the common stockholder’s investment: ROE = Net Income Stockholder’s Equity
    © 2011 Cambridge Consulting Group Inc.
  • 57. Earnings Before Interest Taxes and Amortization
    • EBITDA is an approximate measure of a company's operating cash flow based on data from the company's income statement. It is calculated by looking at earnings before the deduction of interest expenses, taxes, depreciation, and amortization.
    • This earnings measure is of particular interest in cases where companies have large amounts of fixed assets which are subject to heavy depreciation charges and subject to large amortization charges . It is a good way of comparing companies within and across industries.
    • This measure is also of interest to a company's creditors , since EBITDA is essentially the income that a company has free for interest payments . In general, EBITDA is a useful measure only for large companies with significant assets, and/or for companies with a significant amount of debt financing.
    • EBITDA Margin refers to EBITDA divided by total revenue. EBITDA margin measures the extent to which cash operating expenses use up revenue.
    © 2011 Cambridge Consulting Group Inc.
  • 58. Impact of New Lease Treatment EBITA on the Income Statement
    • EBITA Higher
    • Net Income Down
    • Interest Coverage WAY Down
    © 2011 Cambridge Consulting Group Inc. Assumptions:   10 Year Lease, 10,000 SF, $14.40/PSF, 7.5% Borrowing Rate Current Measure Capitalized Measure Year 1 Year 5 Cum. Year 10 Cum.   Year 1 Year 5 Cum. Year 10 Cum. Revenues: 5,000,000   25,000,000   50,000,000   5,000,000   25,000,000   50,000,000 Expenses: 1,000,000 5,000,000 10,000,000   1,000,000 5,000,000 10,000,000 Rent 144,000 720,000 1,440,000                 Total Expenses: 1,144,000   5,720,000   11,440,000   1,000,000   5,000,000   10,000,000 EBITA: 3,856,000   19,280,000   38,560,000   4,000,000   20,000,000   40,000,000   Taxes: 25,000   125,000   250,000   25,000   125,000   250,000 Interest Debt : 250,000 1,250,000 2,500,000   250,000 1,250,000 2,500,000 Interest - Lease :       72,500 303,600 422,700 Depreciation:             101,700   508,500   1,017,000   Net Income: 3,581,000   17,905,000   35,810,000   3,550,800   17,812,900   35,810,300 Interest Coverage: 15.42%   15.42%   15.42%   8.60%   7.77%   7.31%
  • 59. Liquidity Ratios
    • Analyzing liquidity is essential for short term creditors to ensure that the company has adequate funds to meet current debt. A company with poor liquidity is a credit risk. Examples of liquidity ratios include:
      • Current Ratio
      • Quick Ratio
      • Interest Coverage Ratio
    © 2011 Cambridge Consulting Group Inc.
  • 60. Current Ratio
    • The current ratio is simply the relationship between current assets and current liabilities: Current Ratio = Current Assets Current Liabilities
    © 2011 Cambridge Consulting Group Inc.
  • 61. Quick Ratio
    • A stringent test of liquidity that looks at the most liquid current assets, excluding inventories and pre-paid expenses (sometimes called the “acid-test ratio”)
    • Quick Ratio = Current Assets - Inventory Current Liabilities
    © 2011 Cambridge Consulting Group Inc.
  • 62. Interest Coverage Ratio
    • What Does Interest Coverage Ratio Mean? A ratio used to determine how easily a company can pay interest on outstanding debt. The interest coverage ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) of one period by the company's interest expenses of the same period:
    • The lower the ratio, the more the company is burdened by debt expense. When a company's interest coverage ratio is 1.5 or lower, its ability to meet interest expenses may be questionable. An interest coverage ratio below 1 indicates the company is not generating sufficient revenues to satisfy interest expenses. Interest Coverage Ratio = ___ EBIT_____ Interest Expense
    © 2011 Cambridge Consulting Group Inc.
  • 63. Operating vs. Capitalized Recognition 5 Year Lease Break-even is in 2.5 Years
  • 64. Incremental Borrowing Rate (IBR)
    • The Greater the IBR – the Greater the Lease Expense
    • The Incremental Borrowing Rate is defined as the rate that, at the inception of the lease, the lessee would have incurred to borrow the funds necessary to buy the leased property on a secured loan with repayment terms similar to the payment schedule called for in the lease
    • This rate is NOT the same as the corporate discount rate
    • Each lease may have a different rate based on the date of lease inception
    • Each lease must be adjusted to any changes in the IBR at each accounting period. (this may require a substantial investment in time from now on)
    © 2011 Cambridge Consulting Group Inc. PV of Rent @ 7.5% $10,000,000 PV of Rent @ 5.0% $7,500,000 Difference: $2,500,000
  • 65. Mark to Market (MTM)
    • Mark to Market Asset and Liability Accounting may be Required under IAS 17. It is presently required for regulated industries such as Banks.
    • Mark-to-market or fair value accounting refers to accounting for the value of an asset or liability based on the current market price of the asset or liability, or for similar assets and liabilities, or based on another objectively assessed "fair" value.
    • Real estate leases are also re-evaluated based on the market rents in an accounting period.
    • Mark-to-market accounting can make values on the balance sheet change frequently, as market conditions change. In contrast, book value, based on the original cost/price of an asset or liability, is more stable but can become outdated and inaccurate.
    © 2011 Cambridge Consulting Group Inc.
  • 66. What Will IAS 17 Bring?
    • Increase in EBITA
    • Increases in Balance Sheets
    • A Change in Lease vs. Own Decisions
    • A Change in New Lease Terms:
      • Term of Lease
      • Renewal Options
      • Tenant Improvements
      • Gross Leases (Full Service)
      • Lease Modifiers (CPI, Percentage Rent, etc…)
    • Accounting Burden Increase
    • Increase in Senior Management Exposure
    © 2011 Cambridge Consulting Group Inc.
  • 67. What Changes Should I Expect?
    • Changes to Lease Accounting (All Past Leases as Well)
    • Impact of These Changes (Amount of Work, Complexity)
    • Changes to Future Leasing Activities
      • Term Lengths
      • Tenant Improvements
      • Carrying Costs (CAM, Taxes, Utilities, etc.)
      • Renewal Options
    • Changes in the Disposition of Surplus Properties
    • Changes in CRE Function
    • CRE Migration to Asset Management
    © 2011 Cambridge Consulting Group Inc.
  • 68. What Should I Expect To Do?
    • Start with Re-Evaluation of EVERY Lease
      • Re Calculate Every Lease to Capitalized Format
        • Separate Lease Expenses into NNN and Expense Components
      • No Grandfathering – So Every Lease You Have
      • This Re Evaluation Will Occur Every Accounting Period
      • Keep Up to Date Market Rent Evaluations for All Leases
      • Create New Leasing Guidelines Based on Company Guidelines
    © 2011 Cambridge Consulting Group Inc.
  • 69. What Do I Need To Do?
    • Be Prepared!
      • Get Informed (this course) – your peers
      • Other Information – online, service providers, consultants, etc.
      • Internal Help: Accounting, Treasury, The Controller, The CFO
    • Gather the Data
      • All Lease Data
      • All Operating Expense Data and Verify Statements
      • All Separate Agreements – Options
      • Verify Contingent Rent Values
      • While Your At It – Check Leases For Other Issues
        • Environmental Risks
        • ADA Compliance
        • OSHA Compliance
      • Determine If Space Will (or Should) Become Surplus – Important!
    © 2011 Cambridge Consulting Group Inc.
  • 70. What Do I Need To Do - Two
    • Covert The Leases To Capitalized Format
      • Separate All Operating Expenses From Each Lease
      • Determine All Contingent Rent Embedded in Each Lease
      • Determine All Expenses Used in Developing Location
      • Determine All Renewal, Cancellation, Contraction and Expansion Options
      • Verify The “Likelihood” of Any Options Being Exercised
      • Then Determine The Present Value of Each Lease Based on the Approved Incremental Borrowing Rate From Treasury
      • Covert Each Lease to Capitalized Format:
        • Asset: “Right To Use” – Straight Line Amortization
        • Liability: “Obligation To Pay” – IBR Calculation Amortization
    © 2011 Cambridge Consulting Group Inc.
  • 71. What Do I Need To Have ?
    • A Sharp Pencil, Lots of Paper, Lots of Time, Lots of Hot Coffee
    • Senior Management:
      • Your Intentions Through Recommendation to Management
      • All Lease Data and All Associated Billing and Legal Docs
      • A Preliminary IBR For Use with the Leases From Treasury
      • Surplus Property Methodology – How They Account For It
      • Determine Their Expectations
      • Set Up A Reporting Mechanism
      • Show Management Your Initiative
    © 2011 Cambridge Consulting Group Inc.
  • 72. What Will I Have To Do?
    • Intense Catch-up Accounting
    • Basic Paradigm Change
    • New CRE Activities
      • Accounting Efforts
      • More Property Management
      • Increased Management Access for Input
    • The Opportunity
      • Increased Exposure = Increased Value
    © 2011 Cambridge Consulting Group Inc.
  • 73. Communicating with Senior Management
    • Executive Summary:
      • Strategic Context
      • The Recommendation
      • Corporate Impacts
      • Real Estate Impacts
      • Performance Impacts
      • Critical Assumptions
      • Implementation
      • Support Documentation
    © 2011 Cambridge Consulting Group Inc.
  • 74. Communicating Real Estate Impact
    • Adopt a presentation format which condenses detail and responds to those items that senior management wants to address
    • The Executive Summary :
      • An Executive Summary is a transaction report that expresses both your recommendation and defense of your transaction strategy.
      • A good Executive Summary will include the following issues:
        • The transaction’s strategic context
        • The recommended course of action
        • Arguments to support the transaction or strategy
        • The effects of the transaction on the operating unit
        • The transaction’s expected performance in relation to goals.
    © 2011 Cambridge Consulting Group Inc.
  • 75. Executive Summary: Strategic Context
    • This part of the report brings the reader into the necessary frame of reference. It is an introduction that:
      • Identifies the context of the summary
      • Who asked for the report
      • What operating unit is affected
      • What the transaction includes
      • Who is involved
      • Brief chronology of the events leading to the report
      • Summary of the type of analysis used
    © 2011 Cambridge Consulting Group Inc.
  • 76. Executive Summary: The Recommendation
    • The bottom-line position.
    • State your recommendation clearly, succinctly, and up front .
      • For every “what” of the recommendation - be sure to have a “why”
      • Depending on the circumstances, senior management may want you to recommend a second or third option to reflect degrees of sensitivity in the analysis
        • Second and third positions should be set up as tiers:
          • Best case
          • Probable case
          • Worst case
    © 2011 Cambridge Consulting Group Inc.
  • 77. Executive Summary: Corporate Impacts
    • There are four areas of financial impact to explain:
      • Real estate specific impacts
      • Overall company and business unit impacts
      • Accounting and financial impacts
      • Financial ratio impacts
    © 2011 Cambridge Consulting Group Inc.
  • 78. Executive Summary: Real Estate Impacts
    • Key real estate indices to highlight :
      • Change in total occupancy cost as a percent of sales
      • Change in real estate as a percent of assets
      • Net real estate asset change (asset change-liability change)
      • Change in occupancy cost per square foot
    © 2011 Cambridge Consulting Group Inc.
  • 79. Executive Summary: Real Estate Impacts
    • The degree to show real estate impacts is the degree management wants to see them and will readily comprehend.
    • In presenting real estate impacts, include line items affected in the financial statements:
      • Income Statement:
        • Rent
        • Other occupancy cost
        • Depreciation
        • Interest expense (including capital lease interest)
        • Discontinued operations (write-downs, buy-outs)
    © 2011 Cambridge Consulting Group Inc.
  • 80. Executive Summary: Real Estate Impacts
    • Balance Sheet :
      • Property, plant, and equipment assets (PP&E)
      • Mortgages payable, with or without principal pay-down
    • Cash Flow Statement :
      • Depreciation
      • Acquisitions
      • Capital Improvements
      • Discontinued Operations
      • Mortgages and principal pay-downs
      • Changes in cash resulting from a transaction
    © 2011 Cambridge Consulting Group Inc.
  • 81. Executive Summary: Performance Impacts
    • Transactions will impact indices drawn directly from financial statement line items, financial ratios, and in retail businesses, market-related ratios
    • The primary financial statement impacts are:
      • Revenue change
      • Overhead change
      • Net income change
      • Total assets change
      • Total liabilities change
      • Equity change
      • Cash flow change
    © 2011 Cambridge Consulting Group Inc.
  • 82. Executive Summary: Performance Impacts
    • The primary financial ratio impacts are:
      • Profitability, or profit margin change
      • Return on equity change
      • Return on assets change
      • Earnings per share change
      • Book value per share change
      • Quick or current ratio change
    © 2011 Cambridge Consulting Group Inc.
  • 83. Executive Summary: Critical Assumptions
    • A strategy is only as good as its underlying assumptions
    • Critical assumptions are those that have impact on the recommendation and financial conclusions as a whole
    • Heading the list of assumptions to include are:
      • Assumed impact of the transaction on sales
      • Assumed impact of the transaction on other overhead
      • Discount rates
      • Capitalization rates
      • Time requirements to achieve objectives
      • Cost of capital; interest borrowing rates
      • Excluded cost items (legal, commissions, staff time)
      • Tax rates
    © 2011 Cambridge Consulting Group Inc.
  • 84. Executive Summary: Implementation
    • The executive summary should state what happens if the recommendation is approved
    • This can be:
      • A list of priority actions
      • A condensed schedule of activities
      • Any immediate corporate impacts
    © 2011 Cambridge Consulting Group Inc.
  • 85. Executive Summary: Support Documentation
    • It often happens that a senior officer will want to see some item of documentation supporting a financial or operational conclusion
    • The executive summary should anticipate this need by including a list of the support documents used
    • Example documents include:
      • A general narrative of circumstances surrounding the proposed transaction
      • A complete list of assumptions
      • A pro forma income statement
      • A pro forma balance sheet
      • A pro forma cash flow statement
    © 2011 Cambridge Consulting Group Inc.
  • 86. Learning the Language of Finance
    • Understand the dual agenda now confronting the Corporate Real Estate Function
      • Administration of Real Estate
      • Asset Management
    • Divide work into Logistical and Strategic components
    • Determine where your time is best spent:
      • Strategically Focused
      • Management Advisor on Real Estate
    © 2011 Cambridge Consulting Group Inc.
  • 87. Communicating Departmental Value
    • Identify Key Stakeholders
    • Identify Indicators and Measures
    • Develop a Communications Vehicle
    • Develop a Feedback Mechanism
    © 2011 Cambridge Consulting Group Inc.
  • 88. Becoming a Financial Advisor
    • Create a “Linkage” to the Corporate Strategy
    • CRE Strategy Directly Related to Corporate Strategy
    • CRE Tactical Plan
    • Metrics: Financial and Operational
    • Communication
    © 2011 Cambridge Consulting Group Inc.
  • 89. Course Summary
    • The Basic Principles
      • Any Questions?
      • Staying in Touch
    • Our Course Blog
    • On-line File Area
    • Cambridge Consulting Group – Free Support
    © 2011 Cambridge Consulting Group Inc.