Doug Richardson, FROST LLC, 2012 Pork Management Conference, June 19-22 in Savannah, Ga.

1. Proposed New Accounting Standards
For Leases
Doug Richardson
Live Seminar
9:00am – 10:30am
June 21 2012
Relationships backed by performance.

2. Overview and Background
• Leases serve a vital role in many entities’ operations and contain
provisions that range from simple to complex.
• This guidance establishes principles for lessees and lessors for
recognizing, measuring, presenting and disclosing:
a: Assets and liabilities arising from lease agreements;
b: Disclosure information about leasing arrangements;
c: Amounts, timing and uncertainty of the cash flows arising from
lease arrangements.
Leases (Topic 840)

3. Scope
• This guidance applies to all leases, including leases of right-of-use
assets, in a sublease
• This guidance does not apply to the following:
– Leases of intangible assets
– Leases to explore for or use minerals, oil, natural gas and similar
non-regenerative resources
– Leases of biological assets (biological assets include items such
as live animals and plants)
Leases (Topic 840)

4. Rules applicable to the Lessee
• At the date of commencement of a lease, a lessee shall recognize in
the statement of financial position (balance sheet) a right-of-use
asset and a liability to make lease payments.
• This pronouncement requires use of the lessee’s incremental
borrowing rate in calculating the associated interest related to the
lease similar to capitalized interest on fixed assets.
• Similar to the current capital lease rules, the new calculations will be
“interest” expense on the liability to make lease payments.
• The old “rules” go away and every lease except for those identified
within the original scope will create an asset and liability regardless
of the terms of the agreement.
Leases (Topic 840)

5. Initial Measurement - Lessee
• At the date of inception, a lessee shall measure the liability to make
lease payments at the present value at either:
a. The rate the lessor charges the lessee under the lease agreement,
if it can be readily determined, or;
b. The discounted amount using the lessee’s incremental borrowing
rate for loans of similar nature and terms.
Leases (Topic 840)

6. Initial Measurement (continued)
• The lessee shall also measure the right-of-use asset at the amount
of the liability to make lease payments given the payment amount
and the term of the lease, plus any initial direct costs incurred by the
lessee.
• A lessee shall determine the lease term by estimating the probability
of occurrence for each possible term. This consideration must take
into account the effect of any options to extend or terminate the
lease.
Leases (Topic 840)

7. Initial Measurement (continued)
• A lessee shall determine the present value of lease payments
payable during the lease term determined on the basis of the
expected outcome. The expected outcome is the present value of
the probability-weighted average of the cash flows for a
reasonable number of outcomes.
• A. If contingent rentals depend on an index or rate, the lessee shall
determine the expected lease payments using readily available forward
rates or indices. If forward rates or indices are not readily available, the
lessee shall use the prevailing rates or indices.
• B. The lessee should include an estimate of amounts payable to the
lessor under residual value guarantees, if any.
• C. The lessee needs to consider expected payments to the lessor under
term option penalties (if present in the probability estimate range).
Leases (Topic 840)

8. Subsequent Measurement - Lessee
• The associated liability to make future lease payments is amortized
using the interest rate method. (Straight line method is not allowed).
• If facts or circumstances indicate there is a significant change in the
liability since the previous reporting period, a lessee shall reassess
the length of the lease term in accordance with the terms set forth
during initial measurement.
Leases (Topic 840)

9. Subsequent Measurement (continued)
• A lessee shall distinguish changes in contingent rentals and
expected payments under term option penalties and residual value
guarantees that relate to prior periods differently from those that
related to future periods.
For example,
when lease payments depend on the amount of the lessee’s
sales, changes related to sales in the current period or prior
periods are recognized in net income.
Conversley, changes relating to expectations of future sales are
recognized as an adjustment to the right-of-use asset.
Leases (Topic 840)

10. Subsequent Measurement (continued)
• Amortization of the right-of-use asset is to be performed on a
systematic basis from the date of commencement of the lease to
the end of the lease term or over the useful life of the underlying
asset if shorter.
• A lessee shall not change the rate used to discount the lease
payments except to reflect changes in reference interest rates when
contingent rentals are based on those reference interest rates.
When contingent rentals are based on reference interest rates, a
lessee shall recognize any changes to the liability to make lease
payments arising from changes in the discount rate in net income.
Leases (Topic 840)

11. Presentation - Lessee
• Liabilities to make lease payments are to be presented separately
from other financial liabilities
• Right-of-use assets are presented as if they were tangible assets
within property, plant and equipment separately from assets that the
lessee does not lease.
Leases (Topic 840)

12. Presentation (continued)
• Presentation of amortization expense and associated interest shall
be presented separately from other amortization and interest
expense either in the income statement or in the notes.
• Cash payments for leases are to be classified as financing activities
in the statement of cash flows as a separate line item within the
category.
• Short term leases (less than 12 months) is still undecided – They
will be measured at the undiscounted obligation and right to use
asset and amortized in similar fashion or they will be expensed
through the income statement over the lease term (page 5 of
exposure draft)
Leases (Topic 840)

13. Key items to consider
• New requirements for balance sheet and income statement
presentation will require significant changes for entities with debt
agreements which include any ratio covenants.
• Rent expense is replaced with interest and amortization expense.
This could result in a significant increase in EBITDA.
• The balance sheet may significantly change if there are a large
number of leases. Please recall, you don’t simply calculate the
payments based on the original lease term, you must also take into
consideration the probability of continued renewals in your
calculated estimate. This will often result in consideration of the
useful life of the asset.
Leases (Topic 840)

14. Lessor Accounting
• The Lessor must determine when to apply the performance
obligation approach or de-recognition approach at the lease
inception.
• The determination is based on whether the lessor retains exposure
to significant risks or benefits associated with the underlying asset
either:
• During the expected term of the lease; or
• After the expected term of the lease by having the
expectation or ability to generate significant returns by re-
leasing or selling the underlying asset.
Leases (Topic 840)

15. Lessor Accounting (Cont’d)
• If a lessor does retain exposure to significant risks or benefits
associated with an underlying asset, the lessor shall apply the
performance obligation approach to the lease.
• If a lessor does not retain exposure to significant risks or benefits
associated with an underlying leased asset, the lessor shall apply
the de-recognition approach to the lease.
• A lessor shall not change the lessor accounting approach after the
date of inception of the lease.
Leases (Topic 840)

16. Performance Obligation Approach (“PBO”)
• Under the PBO approach, a lessor shall recognize in the statement
of financial position a right to receive lease payments and a lease
liability. The lessor shall not derecognize the underlying asset.
• The right to receive lease payments is calculated at the sum of the
present value of the lease payments using the rate the lessor
charges the lessee and any initial direct costs incurred by the lessor.
• The lease liability is measured at the present value of the lease
payments, discounted using the rate the lessor charges the lessee.
Leases (Topic 840)

17. PBO - Calculation
• The lease term is estimated using a probability weighted approach
using the probability of occurrence for each possible lease term,
taking into account the effect of any options to extend or terminate
the lease. This will often result in much longer lease terms than that
of the original lease term.
• The lessor shall discount all of the lease payments to be received
including an estimate of contingent rentals receivable.
– The exercise price or a purchase option included in a lease is not a lease
payment and the purchase option is not included in determining the present
value of the lease payments.
– The lease payments shall include an estimate of amounts receivable from the
lessee under residual value guarantees that the lessor can reliably measure.
– The lease payments shall include an estimate of expected payments from the
lessee under term option penalties.
Leases (Topic 840)

18. PBO – Subsequent Measurement
• The right to receive lease payments is amortized using the interest
method.
• The remaining lease liability is determined on the basis of the
pattern of use of the underlying asset by the lessee. If the lessor
cannot readily determine the remaining lease liability it shall use the
straight-line method.
Leases (Topic 840)

19. PBO – Subsequent Measurement
• The lessor shall reassess the carrying amount of the right to receive
lease payments arising from each lease if facts and circumstances
indicate there would be a significant change in the right to receive
lease payments since the previous reporting period.

20. PBO – Subsequent Measurement
• The reassessment should include:
– Probable changes in the lease term as an adjustment to the
lease liability to reflect any change in the right to receive lease
payments from changes to the lease term. It should also include
reassessment of the expected amount of any contingent rentals
and expected payments under residual value guarantees that
the lessor can reliably measure;
– All changes in the right to receive lease payments shall be
recognized in net income to the extent that the lessor has
satisfied the related liability or;
– As an adjustment to the lease liability to the extent that the lessor
has not satisfied the related lease liability; however, the lessor
shall recognize any changes that would reduce that liability
below zero in net income

21. PBO – Presentation
• The lessor (or intermediate lessor in the case of a sub-lease) shall
present the following in their statement of financial position:
– Underlying assets
– Rights to receive lease payment asset
– Lease liabilities
– The total of underlying assets minus the lease liability as a net lease
asset or a net lease liability
Leases (Topic 840)

22. PBO – Presentation
• The lessor shall present lease income resulting from the satisfaction
of a lease liability and depreciation expense on an underlying asset
separately, totaling to a net lease income or net lease expense in
the income statement.
• The lessor shall classify the cash receipts from lease payments as
operating activities in the statement of cash flows. If the lessor:
– Applies the direct method, it shall present those cash receipts
separately from other cash flows from operating activities
– Applies the indirect method, it shall present changes in the right to
receive lease payments separately from the changes in other operating
receivables.
Leases (Topic 840)

23. Derecognition Approach
• Under the De-Recognition approach, the lessor shall do the
following at the commencement of the lease:
– recognize on the balance sheet the net present value of the right to receive lease
payments at the commencement of the lease
– De-recognize on the balance sheet the portion of the of the carrying
amount of the underlying asset that represents the rights that have been
transferred to the lessee
– Reclassify the remaining portion of the asset on the balance sheet as a
residual asset.
Leases (Topic 840)

24. Present Value of Lease Payments
• The lease term is estimated using a probability weighted approach
using the probability of occurrence for each possible lease term,
taking into account the effect of any options to extend or terminate
the lease.
• The lessor shall discount all of the lease payments to be received
including an estimate of contingent rentals receivable if it can be
reliably measure using readily available forward rates or indices.
– The exercise price or a purchase option included in a lease is not a lease
payment and the purchase option is not included in determining the present
value of the lease payments.
– The lease payments shall include an estimate of amounts receivable from the
lessee under residual value guarantees that the lessor can reliably measure.
– The lease payments shall include an estimate of expected payments from the
lessee under term option penalties.
Leases (Topic 840)

25. Derecognition – Subsequent Measurement
• The right to receive lease payments is amortized using the interest
method.
• The lessor shall not re-measure the residual asset unless:
– The length of the lease term is materially altered during the time
between measurement evaluation periods.
– The expected amount of any contingent rentals and any expected
payments under residual value guarantees that the lessor can reliably
measure materially change between the measurement evaluation
periods.
Leases (Topic 840)

26. Derecognition – Subsequent Measurement
• The lessor shall apply ASC 310 (impairment guidance) at each
reporting date to determine whether the right to receive lease
payments is impaired and shall recognize any impairment loss in net
income.
Leases (Topic 840)

27. Contracts that contain both service
components and lease components
– An entity shall apply the proposals in the boards’ exposure draft on
revenue from contracts with customers to identify separate performance
obligations within a contract that contains both service components and
lease components.
– If the service component is not distinct, a lessee and a lessor shall
account for the whole of the contract as a lease.
– It is important to clearly delineate service and lease components to
prevent lease treatment of period production expenses.
Leases (Topic 840)

28. Disclosure
• An entity shall disclose qualitative and quantitative financial
information that:
– Identifies and explains the amounts recognized in the financial
statements arising from leases.
– Describes how leases may affect the amount, timing and
uncertainty of the entity’s future cash flows.
• An entity shall aggregate or disaggregate disclosures so that useful
information is not obscured by either the inclusion of a large amount
of insignificant detail or the aggregation of items that have different
characteristics.
Leases (Topic 840)

29. Disclosure
• An entity shall disclose the nature of its lease arrangements,
including:
– A general description of those lease arrangements
– The basis and terms on which contingent rentals are determined
– The existence and terms of options, including for renewal and terminations. A lessee shall
provide narrative disclosure about the options that were recognized as part of the right-of-use
asset and those that were not
– The existence and principal terms of any options for the lessee to purchase the underlying
asset
– Information about the assumptions and judgments relating to amortization methods and
changes to those assumptions and judgments.
– The existence and terms of residual value guarantees
– Initial direct costs incurred during the reporting period
– Restrictions imposed by lease arrangements
– Information about the principal terms of any lease that has not yet commenced if the lease
creates significant rights and obligations for the entity
– The nature and amount of significant subleases
Leases (Topic 840)

30. Disclosure
• An entity shall disclose the nature of its lease arrangements,
including:
– If the entity accounts for short-term leases using the shortcut method that fact, and for
lessees, the amount recognized in the statement of financial position for such short-term
leases
– A lessee shall disclose a reconciliation of opening and closing balances of right-of-use assets
and liabilities to make lease payments, disaggregated by class of underlying asset. The
reconciliation shall separately show the total cash lease payments paid during the period.
– A lessor shall disclose the information about its exposure to the risks or benefits associated
with the underlying asset that is used in determining whether to apply the performance
obligation approach or derecognition approach
– A lessor shall disclose impairment losses arising from leases to which it applies the
performance obligation approach separately from those to which it applies the derecognition
approach
– A lessor shall disclose information about the nature and amount of each class of residual
asset arising from leases to which it applies the derecognition approach
Leases (Topic 840)

31. Disclosure
• An entity shall disclose the nature of its lease arrangements,
including:
– A lessor shall disclose a reconciliation of the opening and closing balances for each of the
following:
• Rights to receive lease payments
• Lease liabilities arising from leases to which it applies the performance obligation
approach
• Residual assets arising from leases to which it applies the derecognition approach
– A lessor shall disclose information about the nature of significant service obligations related
to its leases.
– Information about significant assumptions and judgments and any changes in assumptions
and judgments relating to renewal options, contingent rentals, term option penalties, residual
value guarantees and the discount rate used when determining the present value of lease
payments
– A maturity analysis of the liabilities to make lease payments showing the undiscounted cash
flows on an annual basis for the first five years and a total of the amounts for the remaining
years. The maturity analysis shall distinguish the minimum obligations specified in the lease
and the amounts recognized in the statement of financial position
Leases (Topic 840)

32. Transition and Effective Date
• Although the period for comment has ended on the original
proposed amendment, due to the level and nature of the comments
an updated version of the exposure draft is anticipated to be
released again in 2012.
• While there is not a general consensus in the accounting community
most believe the earliest this could be implemented would be 2015
but more likely 2016 if it is eventually finalized.
• There were 786 comment letters sent to FASB regarding the
standard. By and large these comment letters were highly critical of
FASB and their standard setting process in this area.
Leases (Topic 840)