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[Podcast] Time to prepare... for lease accounting changes
This document discusses proposed changes to lease accounting rules aimed at enhancing transparency by recognizing off-balance sheet lease obligations. It outlines the anticipated timeline for the implementation of new standards, the proposed right-of-use model for lease contracts, and the impact these changes may have on financial reporting and organizational practices. Companies are advised to prepare for these shifts by modifying lease terms, establishing processes, and aligning technology and data tracking systems.
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[Podcast] Time to prepare... for lease accounting changes
- 1. Time to prepare! …for lease accounting changes
- 2. Erik Lange Partner Accounting Advisory Services KPMG MindyBerman Managing Director Capital Markets Jones Lang LaSalle Vivian Mumaw International Director Global Lease Administration Jones Lang LaSalle Today’s guests 2
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- 4. Goal • Recognize off-balancesheet 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* $1,250,000,000,000 44
- 5. Greater transparency about leverage,assets used in operations, and cash flows Greater transparency about residual values Overview Most lease assets and liabilities are off- balance sheet Lessee Lessee Lessor Existing accounting issues The proposal How the proposal is an improvement Recognition of lease assets and liabilities for all leases of more than 12 months Insufficient disclosure about operating leases Enhanced disclosure requirements Lack of transparency about residual values of equipment and vehicles Separately account for residual asset Enhanced disclosures about residual asset’s exposure to risk 55
- 6. Anticipated timeline 2013 20152016 Final standard expected to be issued in 2014 Two year look-back period Revised exposure draft published May 16, 2013 Comment letters due Sept 13, 2013 1 2 3 4 5 Effective date of new standard: 2017 / 2018 2014 2017 66
- 7. Proposed right-of-use model 77 Alease contract conveys the right to use an underlying asset for a period of time in exchange for consideration Lessor Lessee
- 8. Scope • All existingleases – no grandfathering - Operating leases and capital leases • All enterprises – public, private, not-for-profit • All leases – real estate, equipment, leases embedded in service contracts - Regardless of underlying asset location • Short-term leases exempted - 12 months or less, including renewal/extension options 88
- 9. Lease classification 99 LeaseTerm: PV ofFixed Lease Payments Amortization and Interest expense Accelerated expense profile Lease expense Straight-lined over term Type A Non-property Type B Property Low High High EconomicLifeofAsset Fair Value of Asset: • Definition looks to consumption of underlying asset • Test performed at lease commencement or modification
- 10. Summary of changes– lessee accounting Current Operating Lease Model Proposed Lease Model Balance Sheet Off balance sheet Recognize right-of-use asset and liability Income Statement Rent expense • Type A: Non-property leases – Interest and amortization expense • Type B: Property leases – Straight line lease expense Lease Term Non-cancellable term unless significant economic penalties for failure to renew • Options to extend & terminate included if lessee has significant economic incentive to exercise • Reassessment required Variable Lease Payments No contingent rent included • Contingent rent based on an index or rate (i.e. CPI) using spot rate – no forward or forecasted rates used • Performance or usage based rents excluded Purchase Options Bargain purchase option prohibited Included if lessee has significant economic incentive to exercise Short Term Leases • No liability / asset recognized • Rent expense • No liability / asset recognized • Rent expense Impairment No testing required Testing and recognition required 1010
- 11. Lease term 1111 • Theexistence of a termination option • Contingent amounts due under residual value guarantees = Re-assessed periodically *Significant Economic Incentive • The importance of the leased asset to the lessee’s operations • Economic penalties such as significant customization, installation costs or relocation costs • The existence of a purchase option or lease renewal option and the related pricing Contract Asset Entity Market Non-cancelable lease period + Lease extension options (w/ SEI* to exercise) + Lease termination options (w/ SEI* NOT to exercise) = Lease Term
- 12. Discount or Incremental Borrowing Rate Rightof Use Asset / Liability @ inception Initial measurement of expected lease payments Present Value:Apply: Contingent Rent Based on Rate or Index Rent Payments Non-cancellable term FV of Residual Value Guarantees Term Penalties SEI to Exercise Initial Indirect Costs Renewal Period SEI to Exercise Decommissioning Costs Include: Exclude: Lease Incentives Performance / Usage Rent Operating Expense Capitalized lease obligations + – × = 1212
- 13. 1313 Effect on accounting 300,000 350,000 400,000 450,000 500,000 550,000 600,000 650,000 12 3 4 5 6 7 AnnualExpense($) 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 Payments Type B Income Statement: Straight-lined lease expense Type A Income Statement: Interest and amortization expense
- 14. Receivable and ResidualModel • Lease is the sale of a more than insignificant portion of the underlying asset • Recognize profit upfront on receivable portion, if any Type A – Non-property Leases Type B – Property Leases Financing Receivable Residual Interest No receivable or residual recognized PP&E Operating Lease ModelReceivable and Residual Model Operating Lease Model • Lease is the service of providing access to an underlying asset for a stated period of time • Income recognition similar to current U.S. GAAP • No fair value accounting for property companies Lessor accounting 1414
- 15. Other lease arrangements NewApproach Subleases • Recognize primary lease obligation • Account for sublease arrangement separately • Present on net basis Sale-leasebacks • Determine if financing or sale • Immediate gain recognition for sale • Purchase options at market acceptable Build-to-suits • Accounting based on lease classification • Principles-based tests 1515
- 16. Disclosure requirements The newstandard is expected to require the accumulation of additional data points and assumptions, which include but are not limited to: • Payment amount considering lease term, including the significant economic incentive 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 lease expense and interest and amortization expense methods 1616
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- 19. 1919 Increase in P&Lburden, accelerated expense for certain leases Different accounting of similar leases Change in lease vs. own decision-making Change in expense allocation to business units Potential violation of financial covenants Increase in financial reporting burden Substantial increase in liabilities on the balance sheet Change in desired lease terms and structure No expected change in credit ratings Implications for corporate occupiers
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- 21. Transaction strategies –myths and realities Own vs. lease decision-making Own instead of lease • Use of corporate capital • Ability to control or own certain property • Operating flexibility • Economic vs. accounting-based decisions Minimize or avoid capitalization Use shorter lease terms • Commercial feasibility and economic terms • Short-term lease exemption – principles-based standard • Termination options – principles-based standard Limit / eliminate renewal options • Evaluated through lens of significant economic incentive • Commercial feasibility Creative rent structures • Usage or percentage of sales-based rents Creative lease structures • Use of purchase options and residual value guarantees 2121
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- 23. Key Steps Strategy Modify leaseterms l Financing arrangements Operations Define roles l Develop processes l Modify BU metrics l Align resources Technology / Data Collect data for D1 impact l Review / modify technology l Assess impact l Design reporting 2017+ Maintain 2014 Implement Now Plan 23
- 24. Technology and data DataTracking Reporting Accounting Current • Lease terms, options, rent schedule • Deposits, allowances • Conditions re. RVG, option penalties, decommissioning, BPO • Fixed term lease obligation • Rent roll / income • Future critical dates • Abstract summaries • Rent expense, income • Cash receipts • Budget • Straight-line rents Additional Requirements • Direct costs • IBR / Discount Rate • Value estimates (economic life, asset value, exit costs, RV) • Economic incentive factors • Assets and obligations • Amortization schedules • Reassessment support • Expanded portfolio data • Asset and obligations for balance sheet • Amortization using estimated life • Financing costs • Reassessment impact 2424
- 25. Calculate/anticipate impact ofchanges Establish cross-functional teams/processes Facilitate strategic/tactical decision support Lease Portfolio (real estate and equipment) Action Plan Staffing Levels Change Management Communications, Training Governance Framework Business Assumptions, Work Routines and Processes Information Systems Data Collection/Management, Reporting Identify data/resource gaps Information Systems Human Resources Lease Information Organization Positioning your lease portfolio 2525
- 26. What should Ido now? • Get educated and stay informed! - Visit www.leaseaccountingchanges.com to gain access to educational materials and stay abreast of on-going developments • Get vocal! - Submit comments by September 13, 2013 via FASB/IASB website 2626 • Get prepared! - Understand the impact of the changes on your organization - Advise your internal stakeholders - Plan for change
- 27. For more information 2727 MichaelBilling Executive Vice President Strategic Consulting Jones Lang LaSalle michael.billing@am.jll.com +1 312 228 2638 Erik Lange Partner Accounting Advisory Services KPMG elange@kpmg.com +1 212 872 6654 Mindy Berman Managing Director Capital Markets Jones Lang LaSalle mindy.berman@am.jll.com +1 617 316 6539 Vivian Mumaw International Director Global Lease Administration Jones Lang LaSalle vivian.mumaw@am.jll.com +1 312 228 2878