The document summarizes the key aspects of a presentation on the proposed changes to lease accounting standards in Australia. The proposed changes would require lessees to recognize lease assets and liabilities on the balance sheet for both financing and operating leases. This would represent a significant change from current requirements where operating leases are held off-balance sheet. The changes are expected to have impacts such as increasing reported assets and liabilities, changing the presentation of lease expenses, and potentially affecting key financial ratios.

1. Presenter: Anne Lockwood, Principal, Audit and Assurance
Leases: Effect of Exposure Draft on Lease Accounting
March 2012

2. Objectives
Lessee Accounting
 WHY
 WHEN
 WHAT
 IMPACTS..................
It should be noted that this presentation is a summary for general information only and the relevant standards
must be reviewed for clarity in regard to application. For example, Tier 2 application is not discussed.
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3. The current Environment – AASB117
 Classification
 Financing
 Operating
Operating Leases are held off Balance Sheet and costs are recognised as incurred.
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4. The Proposed environment - AASB Exposure Draft ED202R
WHY?
• Compliance with International Financial Reporting Standards (IFRS)
• Convergence with US Financial Accounting Standards Board (FASB)
• Basis is that “right of use” meets the definition of an asset
• Lessee controls the asset – contract unconditional right
• Future economic benefits to be derived from use of the asset
 Unconditional obligation to make future lease payments meets definition of a
liability
• Consistent accounting for all leases improves comparability of financial
statements
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5. The Proposed environment - AASB Exposure Draft ED202R
WHEN?
 New ED expected to be issued 2H 2012
 Application expected 1 January 2015…..number of set backs
 Effective 31 Dec 2015/30 June 2016
 Comparatives….retrospective application
 Recognise and measure all outstanding contracts within the scope as at 31 Dec 2015/30 June 2015
 Half year reports…….30 June 2015….3 years away.
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6. The Proposed environment - AASB Exposure Draft ED202R
WHAT?
 Applies to all leases, including sub leases except
 Intangible assets
 Exploration and biological leases
 Onerous contracts
 Service component contracts if separable
 Initial Recognition
Dr Right of Use Asset – Intangible asset
Cr Lease Liability – discounted lease payments
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7. The proposed environment - AASB Exposure Draft ED202R
WHAT?
 Initial Measurement
 Liability – PV of the lease payments discounted using incremental borrowing rate OR if readily
determined the rate implicit in the lease
 Lease term – estimating the probability of occurrence for each possible term
 Take into account options to extend or terminate – probability based
 Cash out flows – expected outcome using all relevant information and probability weighted
 Estimate of contingent rentals – use of forward or prevailing rates/indices
 Estimates of amounts payable under residual value guarantees
 Term option penalties
 Deduct lease incentives – new ED
 Capitalise initial direct costs – new ED
Significant judgment and estimation required – may be different for each lease
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8. The proposed environment - AASB Exposure Draft ED202R
WHAT?
 Example – probability of lease term
 Non-cancellable 10 year lease, two options to renew for 5 years – total of 20 years
 Determine probability lease will run for:
 10 years - 40%
 15 years - 30%
 20 years - 30%
You would determine lease term as 15 years as there is a 60% chance the lease will run longer than 10
years……..more likely than not to occur
 10 years - 50%
 15 years - 40%
 20 years - 10%
50/50 – what is more probable now???????
 Consider – contractual factors, regulation, financial cost, business factors, past
practice and intentions
 New ED – non-cancellable period only unless significant economic incentive
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9. The proposed environment - AASB Exposure Draft ED202R
WHAT?
 Example – probability of expected cash outflows
 Base rental payments of $70,0000pa plus outgoings plus contingent rentals on sales volumes, plus
CPI increases and penalties for early exit after 10 years of $10,000 per year
 Prior example determined most likely lease term of 15 years
 $70,0000*15 years
 Estimate outgoings for 15 years, ……rates, electricity, waste, contributions etc
 Estimate sales performance and contingent rentals for 15 years…..consistent assumptions with
budgets and forecasts/impairment testing
 Determine CPI increases…..prevailing/forward rates (new ED – spot rates)
 Penalty of $50,000 for early exit clause
Discount at incremental borrowing rate/rate implicit in lease
 New ED – Variable lease payment – high recognition threshold of “reasonably
certain”
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10. The proposed environment - AASB Exposure Draft ED202R
WHAT?
 Subsequent Measurement
 Judgments and estimates change
 If change in facts and circumstances indicates significant change in lease liability – re-assess
lease liability .
 Adjust to Right of Use Asset
 Change of lease term
 Changes in cash outflows relate to future periods
 Adjust to profit and loss
 Changes relate to current and prior periods
 Discount rate does not change
 Right of use Asset – amortised in accordance with AASB 138
 Useful life
 Systematic basis
 Right of use asset – revaluation and/or impairment
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11. The proposed environment - AASB Exposure Draft ED202R
WHAT?
 Presentation
 Statement of Financial Position
 Liability to make lease payments separately
 Right of use assets within PPE or investment property – tangible or intangible assets?
 Statement of Financial Performance
 Amortisation of lease assets separately
 Interest exp on lease payments separately
 Statement of Cash Flows
 Cash payment for leases as financing activities
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12. The proposed environment - AASB Exposure Draft ED202R
WHAT?
 Presentation
 Disclosure
 Quantitative and qualitative information
 Describe lease arrangements
 Basis and terms for contingent rentals
 Existence of terms of options – if recognised in RoU asset or not
 Amortisation method – judgments and estimates
 Existence and terms of Residual Value Guarantees
 Sublease details
 Reconciliations of opening and closing lease liabilities and RoU asset by class of asset
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13. Lessees accounting - impacts
 Grossed up Assets and Liabilities
 Initially - net assets remain the same
 Subsequently – differ due to amortisation policy v lease payment may not always net off - timing
 Lease expenses
 Amortisation and interest expense recognised instead of operating costs – now below EBITDA line
BUT increase in interest costs
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14. What is the main impact on YOU?
 Loan covenant calculations
 Market indicators
 STI ratios
 Tangible asset backings
 RoR on assets
 Interest cover ratio
 Margin growth
 EBITDA growth
 EPS
 Additional administrative/audit time and costs.
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15. Back of the envelope assessment
 What are your current disclosures around operating lease commitments?
 Apply a discount factor and gross up balance sheet
 What are your current operating lease costs?
 Remove from operating expenditure to below EBITDA – split amortisation/interest
 Recalculate reported/utilised ratios
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16. Short term leases
 Usually those settled within 12 months.
 Lessee may elect on a lease by lease basis to recognise (undiscounted) a
liability to make payments, and a right to use asset. Lease payments recognised
in P&L over the term.
 Lessor may elect not to recognise either an asset or liability arising, nor
derecognise the underlying asset. Underlying asset dealt with in accordance with
their relevant standard. Lease payment are recognised in P&L over the term.
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17. What can you/should you do now?
 Perform an impact assessment on the specific effect this will have on your
business
 Include “opt out of changes in Acc Std’s” clauses in agreements
 The actual effect will depend on the facts surrounding your affairs
 Consider impacts when negotiating debt agreements, STI arrangements etc
 IT SHOULD NOT IMPACT YOUR LEASE NEGOTIATIONS
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