The document discusses the current and expected future framework for lease accounting under IFRS and US GAAP. It is expected that in 2013, final rules will be issued requiring all leases, except short-term leases, to be recognized on company balance sheets. This will substantially impact both lessees and lessors. Lessees will see increased administrative costs and complexity from the increased reporting requirements. Lessors will have to defer revenue recognition related to residual assets. Both lessees and lessors will need to prepare for the changes through investments in new processes, IT systems, and financial products and services.

1. Navigating through the new lease regulations
EFRAG
Roel Vriens, February 23, 2012

2. Navigating through the new lease regulations: EFRAG
Content of presentation
} Leasing – Current and expected future framework
} Expected business impact for lessees and for vendors/lessors
} Is there still a future for leasing?
} Specific topics
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3. Leasing - Current and expected future framework

4. Navigating through the new lease regulations: EFRAG
Leasing: Current framework
Differences local GAAP, IFRS and US GAAP
} Criteria to differentiate between
Financial Lease (on balance sheet) and
Operating Lease (off balance sheet)
– NPV of the minimum lease payments
– Economic life versus term of lease contract
Lease payments Economic life
Local GAAP 90% (indication) 75% (indication)
IFRS IAS 17 ‘substantially all’ ‘major part’
US GAAP SFAS 13 90% 75%
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5. Navigating through the new lease regulations: EFRAG
Leasing: Expected future framework
History
1996: first Discussion 2009: IASB and FASB 2013: Final rules still
Paper (McGregor/IASB) in Discussion Paper ‘Leases: expected in 2012? Re-
which the need to adapt Preliminary Views’ with exposure draft is expected
rules was explained on a
fairly detailed level
Overriding Lessees
main focus on principle in Q2 2012.
All leases to be shown on
the balance sheet of the
1996 2000 2009 2010 2012 2016
lessee
2000: Second Discussion August 17, 2010: Effective Date not decided,
Paper IASB Exposure Draft as result of expectation January 2016.
the 2009 Discussion Paper But date of initial application
Over 785 companies, (DIA) one or two years
including DLL, have earlier, i.e., 2015 (IFRS) and
responded! 2014 (US GAAP)
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6. Navigating through the new lease regulations: EFRAG
Leasing: Expected future framework
Lessor accounting: Receivable and residual approach
} One model: Receivable and Residual (R&R) approach
– Very similar to current finance lease accounting, but more complex
– Result is what equipment leasing industry has been pressing for
} Important differences compared to current situation:
– Two assets on lessor’s balance sheet (R&R)
– Both assets generate a return equal to discount rate in the lease
} Portion of income to defer when fair value of leased asset is greater
than lessor’s carrying value:
– This is typical for captives, not applicable to other (bank-owned) lessors
– Part of excess fair value associated with the residual asset to be deferred
until disposal, re-lease, or realization of the residual asset
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7. Navigating through the new lease regulations: EFRAG
Leasing: Expected future framework
Observations
} Sound conceptual framework for lessors and lessees:
– Proposal (December 23, 2011) much better than 2010 Exposure Draft and
current rules
– Acceptance of capitalizing all, except short term, leases by the lessees
– Choice of lessor R&R model supported by equipment leasing industry
– One type of lease for both lessees and lessors, mirroring the lessee
position at the lessor
} Areas to be addressed:
– Eliminating frontloading of lease interest expenses could impact the sound
framework mentioned above. Would that be a good decision?
– Cost versus benefits of new standard, options to consider are minimizing
disclosures and further simplifications or more explicit guidance on:
} Hurdle of a “significant economic incentive” to renew/continue the lease
} Lessor accounting for residual values guarantees
} Accounting for variations based on index or interest rates
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8. Expected business impact
Lessees and Vendors/Lessors

9. Navigating through the new lease regulations: EFRAG
Statement
All parties involved, vendors, dealers, lessors (captives and vendor
finance companies), end-users and lessees will be substantially
affected by the changes in lease accounting
} Revenue recognition (P&L)
} Costs/Investment to be made (P&L)
– Frontloading of interest cost for lessees
} On and Off balance sheet treatment
} Business and co-operation models
} Financial products and services offered
} Changing playing field in marketplace
} Processes and IT
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10. Navigating through the new lease regulations: EFRAG
The changing environment
Lessees
} Lessees to recognize all leases on the balance sheet resulting in:
– Increase in administrative burden, due to required increase in data
collection, monitoring and internal and external reporting
– Increase of complexity, due to changed definitions, methods of
calculations and combining data from multiple internal and external
sources
– Deterioration of debt-equity ratio as assets and liabilities increase.
Lessees may no longer meet existing loan covenants or face lower credit
ratings
– Major task to transition, due to all operating leases coming on balance
sheet for the first time
} Thus, lessees will search for products and services that:
– Mitigate the impact
– Do not require the lessee to change its processes and IT systems
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11. Navigating through the new lease regulations: EFRAG
Expected customer impact
Preparation for new rules
} 54% of business globally are not aware of the proposed move of all
but short-term leases onto the balance sheet
– Survey 2800 businesses worldwide
} Awareness of change by country
– High: USA: 69%, Mexico: 68%, Chile: 63%
– Medium: UK: 44%, Germany: 27% (EU: 38%)
– Low: China: 5%, Denmark: 8%, Turkey: 14%
} Expected consequences:
– 33% increase of costs and complexity
– (only)15% increase in transparency
– 12% change in behavior with respect to leasing
Source: survey Grant Thornton International Business Report (September 2011)
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12. Navigating through the new lease regulations: EFRAG
The changing environment
Vendors / Lessors
} Vendors to defer revenue and related margin allocated to the residual
asset till disposal of that asset
} Vendors/lessors to provide (new) products and services to:
– Lessees in answer to the new environment
– Dealers, supporting them to sell leasing in the new environment
} Thus, vendors will search for solutions that:
– Allow for full upfront revenue and margin recognition
– Derecognize their lease portfolios (off balance sheet treatment)
– Accommodate requests from dealers and lessees to limit the end-user’s
administrative burden and need for more information and transparency
} Vendors to tune their current business models to new environment
– Should they move to in-house financing or (other) third party vendor
leasing companies?
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13. Navigating through the new lease regulations: EFRAG
Revenue deferral related to residual asset
Impact differs per major asset types / industries
Asset Types RoU Investment value
IT / Office equipment 94 100
Forklifts 85 100
Industrial 65 100
Cars 65 100
Transportation 55 100
} Captives (vendors with in house lease book) will see an important shift
in the pattern of revenue recognition over time compared to today
} Lessees will no longer have a possibility of Off-balance sheet financing,
but lease solutions are still partial off balance, as the assumed
Residual Value is on the balance sheet of the lessor and not part of the
Right-Of-Use asset
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14. Navigating through the new lease regulations: EFRAG
Challenges for lessees and vendors/lessors
} Bank covenants (lessees)
– Deterioration of financial ratios e.g., solvency
} IT and leasing software (own and 3rd party)
– 60% of respondents use MS Excel to record their operating leases. That
may require investments in software to track and account for leases
} Duty of care of vendors/lessors to end-users
– Leases signed today are likely to be affected by new rules (e.g., for
contracts with duration in excess of 4 years)
– Communication and providing information to lessees
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15. Is there still a future for leasing?

16. Navigating through the new lease regulations: EFRAG
Customers should continue to lease because:
} Use of equipment at low monthly costs
} 100% cost coverage: equipment, service, shipping, installation, etc.
} Flexibility of mid term upgrades and end of term options: easy way to
gain use of the latest equipment or technology with maximum
financial flexibility
} Easier cash flow forecasting: fixed payments allow your customer to
budget effectively and avoid risk of future inflation or interest rate
rises
} Lease commitments often do not reduce existing cash and credit
lines
} Less costly and lower cash out than a (bank) loan
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17. Navigating through the new lease regulations: EFRAG
Vendors should continue to offer leasing to
their customers
Because leasing puts vendor in control
} Protecting customer base against other vendors
} Easier closing of deals: offering leasing can remove price objections
with customers
} Increasing sales and margins: offering a finance package makes it
easier to sell added value products such as service and
maintenance
} Increasing opportunities for upgrade sales: leasing cycles are
relatively short, offering more opportunities to approach the customer
to sell upgrades or new products
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18. Navigating through the new lease regulations: EFRAG
How can the structure be optimized?
Understanding the objectives of all the players in the market
Vendor Leasing Model
Lessor
End-user/ Manufacturer/
lessee vendor
1. Lessee: reduce admin burden and not on the balance sheet
2. Vendor: sales treatment and derecognition of assets
3. Lessor: lien on or ownership of the financed equipment 18

19. Specific topics

20. Navigating through the new lease regulations: EFRAG
Consequences for lessees
} Higher lease cost in the beginning of the lease period compared to
the current lease accounting standards
Lease cost comparison
250.00
200.00
Current
Proposed
150.00
100.00
Year 1 Year 2 Year 3 Year 4 Year 5
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21. Navigating through the new lease regulations: EFRAG
Economic impact of lease proposals
Study of Equipment Leasing and Finance Foundation
} Study based on 2010 financial data of 1800 US based, publicly traded
companies. Assuming new lease rules implemented in 2010
} Frontloading of lease interest expenses increases costs by + 9.6%
and a -2.4% reduction in pre-tax net income for the first year
– However is the method used fair? Which growth assumptions are used?
} Capitalization of operating leases: increase in assets of $2 trillion; and
+11% more debt
– This replaces the current estimates. Will there be significant differences?
} Lease standard reduces GDP by $10 billion and 60,000 less jobs
– Significant impact, but based upon what assumptions?
} Investigated companies face $96 billion (or - 0.5%) less equity
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22. Navigating through the new lease regulations: EFRAG
Lease classification (current status)
} Today, classification of the same lease contracts within Office
Technology industry differ significantly between:
– Vendor/Lessor, reporting about 80% Finance Leases and 20% Operating
Leases
– Lessee/End-user, reporting these contracts as 30% Finance Leases and
70% Operating Leases
} Reasons for different classification by parties involved include:
– Different assessment of economic life (75% rule in FAS13)
– Different discount factor, incremental borrowing rate versus rate
embedded in the lease (90% rule in FAS13)
– Third party residual value guarantees issued to vendor
– Immaterial items or non-compliance to the rules
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23. Navigating through the new lease regulations: EFRAG
Lease classification (future status)
Concerns lease versus service classification – a new bright line?
} Criteria to determine whether a contract contains a lease:
– Right to use a specified asset, and
– Right to control the use of that asset
} Vendor/lessors may prefer a lease over a service to have sales
treatment of the equipment sold through a lease
} Lessees may prefer a service over a lease to have fixed periodic cost,
nothing on the balance sheet and very limited administrative burden
} Would it be possible that under the new standard a contract is:
– Classified as a service but is a lease by common sense? What about
long-term service contracts with embedded equipment?
– Classified as a lease for the vendor/lessor and as a service for the
lessee/end-user?
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