An Update on the FASB’s LeaseProjectSeptember 25, 2012                     Douglas Boedeker, CPA, CMA                     ...
Course Outline   Why is the FASB doing this?   FASB timeline   Project scope   Recording by lessees   Recording by le...
The FASB/IASB Lease Project – WHY? Leases are an important source of finance – more information required. Concern over l...
FASB Timeline Exposure Draft Issued – August 17, 2010 Public Comment Period Ended – December 15, 2010, 786 comment lette...
A Key Fact to Remember This MorningEverything we talk about today is TENTATIVE!!!     4                                   ...
What is a “lease”?A contract contains a lease if:The fulfillment of the contract depends on the use of a specified asset; ...
Scope of the proposed standard                         Simple – ALL LeasesExcept :           Leases of intangible assets  ...
What about service components? Each contract must be analyzed for lease and non-lease components. Contract payments are th...
Important Exception for Short-Term Leases Leases with a maximum possible lease term of 12 months or less can  be accounte...
Lessee Accounting 9                    © Copyright Tate & Tryon 2012
There will be two types of leases…. Interest & Amortization Approach  -   Lessee consumes more than an insignificant port...
There will be two types of leases… Straight-Line Expense Approach  -   Lessee does not consume more than an insignificant...
Initial Recording by a Lessee1. Determine the “lease liability”  (Future anticipated cash payments discounted to present v...
Lessee Subsequent RecordingInterest & Amortization Approach1. Amortize the “right of use asset”. (Probably on a straight-l...
Lessee Subsequent RecordingStraight-Line Expense Approach1. Figure out what the monthly straight-line expense under the le...
Lessor Accounting 15                    © Copyright Tate & Tryon 2012
There will be two types of leases… Receivable & Residual Approach  -   Lessee consumes more than an insignificant portion...
There will be two types of leases… Straight-Line Revenue Approach  -   Lessee does not consume more than an insignificant...
Receivable & Residual Approach – The Basic Steps1.   Leased asset is removed from the books. Profit on sale gets     recog...
Straight-Line Revenue Approach – The Basic Steps1. Leased asset stays on the books. It continues to be   amortized in its ...
Calculation Quirks 20                     © Copyright Tate & Tryon 2012
“Asset Consumption”Here’s something directly from the FASB/IASB staff……     21   Slide from Leases: Project Update, July 2...
Figuring out the “Lease Term”Here’s the latest proposed definition:“The lease term is the non-cancellable period for which...
Figuring out the “Lease Term”Factors to weigh when considering the presence of significant economic incentive:    Contract...
Determining Future Lease Payments  The calculation of future lease payments includes:      Fixed increases specified in th...
Example - Determining the “lease term”Assume a tenant enters into a five year lease with two five-year renewaloptions.The ...
Example - Calculation of Lease PaymentsLet’s assume that our lease has an initial base rent of $1,000,000 with a 3% annual...
Example - Calculating the Liability and AssetLegal fees of $265,000 were incurred as part of the review of the lease docum...
Example - Entries for year one…                                                     Debit                 Credit          ...
Items to consider each yearLease term: Have factors changed regarding economic incentives toexercise or not exercise renew...
Transition Early adoption will likely be permitted. Generally a retrospective approach, with a number of modifications d...
Good Luck! You might want to sneak away sometime before this all goes final......       31                               ...
Speaker BiographyDouglas Boedeker, is a partner within Tate & Tryon’s Audit andAssurance Services unit and is also activel...
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Update on FASB Lease Project

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Key information on how FASB's attempts to integrate lease accounting will impact most tax exempt organizations including specific examples and what if situations presented by Nonprofit CPA Firm - Tate Tryon CPAs

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Update on FASB Lease Project

  1. 1. An Update on the FASB’s LeaseProjectSeptember 25, 2012 Douglas Boedeker, CPA, CMA Dboedeker@tatetryon.com 202-419-5106
  2. 2. Course Outline Why is the FASB doing this? FASB timeline Project scope Recording by lessees Recording by lessors Transition 1 © Copyright Tate & Tryon 2012
  3. 3. The FASB/IASB Lease Project – WHY? Leases are an important source of finance – more information required. Concern over lack of comparability. Concern over “bright-line” test for operating vs. capital lease. 2 © Copyright Tate & Tryon 2012
  4. 4. FASB Timeline Exposure Draft Issued – August 17, 2010 Public Comment Period Ended – December 15, 2010, 786 comment letters were received Numerous redeliberations have taken place in 2011 and 2012 A “New & Improved” Exposure Draft is anticipated in 4th Quarter of 2012 (they might extend the public comment period past 120 days) Additional outreach and public comments in 2013 Final standard to be issued - ????? 3 © Copyright Tate & Tryon 2012
  5. 5. A Key Fact to Remember This MorningEverything we talk about today is TENTATIVE!!! 4 © Copyright Tate & Tryon 2012
  6. 6. What is a “lease”?A contract contains a lease if:The fulfillment of the contract depends on the use of a specified asset; andthe contract conveys the right to control the use of the specified asset for a period of time.Important note:A physically distinct portion of a larger asset can be a “specified asset”. 5 © Copyright Tate & Tryon 2012
  7. 7. Scope of the proposed standard Simple – ALL LeasesExcept : Leases of intangible assets Leases of mineral rights, etc. Leases of biological assetsFASB is still considering whether leases of internal use software shouldbe accounted for under the new rules. 6 © Copyright Tate & Tryon 2012
  8. 8. What about service components? Each contract must be analyzed for lease and non-lease components. Contract payments are then allocated between the components based on observable purchase prices. If there are no observable purchase prices, all payments under the contract would be accounted for like a lease. Lessors would allocate payments in accordance with revenue recognition guidance. Question: Are items such as property taxes, insurance, and maintenance a “service” or part of a “lease”? 7 © Copyright Tate & Tryon 2012
  9. 9. Important Exception for Short-Term Leases Leases with a maximum possible lease term of 12 months or less can be accounted for the “old way”. No lease asset or liability is recognized. Any renewal options are considered in the determination of the 12 month maximum period. Thus, month-to-month leases will likely not qualify as a short-term lease! 8 © Copyright Tate & Tryon 2012
  10. 10. Lessee Accounting 9 © Copyright Tate & Tryon 2012
  11. 11. There will be two types of leases…. Interest & Amortization Approach - Lessee consumes more than an insignificant portion of leased asset. - Essentially similar to today’s “capital lease”. - Will generally apply to equipment leases. 10 © Copyright Tate & Tryon 2012
  12. 12. There will be two types of leases… Straight-Line Expense Approach - Lessee does not consume more than an insignificant portion of leased assets. - Essentially similar to today’s “operating lease” coupled with a balance sheet gross-up. - Will generally apply to land/building (property) leases. 11 © Copyright Tate & Tryon 2012
  13. 13. Initial Recording by a Lessee1. Determine the “lease liability” (Future anticipated cash payments discounted to present value at either the lessee’s incremental borrowing rate or, if known, the rate implicit in the contract.)2. Determine the “right of use asset” (Lease liability plus initial direct costs of acquiring the lease.) 12 © Copyright Tate & Tryon 2012
  14. 14. Lessee Subsequent RecordingInterest & Amortization Approach1. Amortize the “right of use asset”. (Probably on a straight-line basis.)2. Adjust the lease liability using the effective interest rate method. (Essentially treated like a note payable.)3. Reassess significant assumptions and adjust for current facts and circumstances. Thus, the P&L reflects amortization expense and interest expense. Total expense under the lease gets “front loaded”. 13 © Copyright Tate & Tryon 2012
  15. 15. Lessee Subsequent RecordingStraight-Line Expense Approach1. Figure out what the monthly straight-line expense under the lease would be – just like the “FAS 13” calc. done today.2. Adjust the lease liability balance sheet account as if it were amortized like a loan payable. (Each lease payment has a “principal” and “interest” component.)3. The right of use asset gets debited or credited in order to make the cash, lease expense, & lease liability adjustment balance. In other words, the right of use asset becomes a “balancing account”. Or, it gets “plugged”. 14 © Copyright Tate & Tryon 2012
  16. 16. Lessor Accounting 15 © Copyright Tate & Tryon 2012
  17. 17. There will be two types of leases… Receivable & Residual Approach - Lessee consumes more than an insignificant portion of leased asset. - Profit on “sale” is recognized with periodic interest income. - Will generally apply to equipment leases. 16 © Copyright Tate & Tryon 2012
  18. 18. There will be two types of leases… Straight-Line Revenue Approach - Lessee does not consume more than an insignificant portion of leased assets. - Essentially similar to today’s “operating lease” – rental income is recognized on a straight-line basis. - Will generally apply to land/building (property) leases. 17 © Copyright Tate & Tryon 2012
  19. 19. Receivable & Residual Approach – The Basic Steps1. Leased asset is removed from the books. Profit on sale gets recognized here – based on what % of total FV is getting leased.2. Receivable is booked for the “right to receive lease payments”. (Calculated as the PV of the future anticipated lease payments using the discount rate implicit in the lease.)3. A “residual asset” is recorded – essentially the unconsumed portion of the leased asset. It is booked at the current present value, and then accreted up to gross value by the end of the lease term.4. Subsequent income is recognized in the form of interest income on the lease receivable and accretion income on the residual asset. 18 © Copyright Tate & Tryon 2012
  20. 20. Straight-Line Revenue Approach – The Basic Steps1. Leased asset stays on the books. It continues to be amortized in its usual manner.2. Rental income would be recognized on a straight- line basis over the life of the lease. (Thus, we’ll still need some kind of “accrued rent receivable” balance sheet account.) Does this sound familiar? 19 © Copyright Tate & Tryon 2012
  21. 21. Calculation Quirks 20 © Copyright Tate & Tryon 2012
  22. 22. “Asset Consumption”Here’s something directly from the FASB/IASB staff…… 21 Slide from Leases: Project Update, July 2012 by FASB & IASB © Copyright Tate & Tryon 2012
  23. 23. Figuring out the “Lease Term”Here’s the latest proposed definition:“The lease term is the non-cancellable period for which the lessee has contracted with the lessor to lease the underlying asset, together with any options to extend or terminate the lease when there is a significant economic incentive for an entity to exercise an option to extend the lease, or for an entity not to exercise an option to terminate the lease.” 22 © Copyright Tate & Tryon 2012
  24. 24. Figuring out the “Lease Term”Factors to weigh when considering the presence of significant economic incentive: Contract-based: Bargain renewal options, commitments to restore asset at end of term. Asset-based: Lessee installs significant leasehold improvements or unique location. Entity-specific: The historical practice of the entity, management’s intent, and common industry practice.The lease term should be reassessed when there are significant changes in the relevant factors. 23 © Copyright Tate & Tryon 2012
  25. 25. Determining Future Lease Payments The calculation of future lease payments includes: Fixed increases specified in the contract; Variable payments that are based on an index or rate; (The Spot Rate is to be used to measure the future anticipated lease payments.) Purchase options with significant economic incentive to exercise. This is a dramatic simplification from the original ideas in the exposure draft that would have required a probability-weighted calculation of all contingent lease payments!The revised standard will include guidance on how to account for lease incentives provided by the lessor to the lessee. 24 © Copyright Tate & Tryon 2012
  26. 26. Example - Determining the “lease term”Assume a tenant enters into a five year lease with two five-year renewaloptions.The tenant is installing a state of the art research laboratory in the facility.The laboratory is very expensive and is considered a major investment bythe tenant.Common industry practice is to completely replace laboratory facilities everyten years.There appears to be significant economic incentive for the tenant toexercise the first renewal option.A 10 year term will be used when initially recording the lease. 25 © Copyright Tate & Tryon 2012
  27. 27. Example - Calculation of Lease PaymentsLet’s assume that our lease has an initial base rent of $1,000,000 with a 3% annualescalation. Our tenant’s incremental borrowing rate is 8%. Year Payment 1 $ 1,000,000 2 1,030,000 3 1,060,900 4 1,092,727 5 1,125,509 6 1,159,274 7 1,194,052 8 1,229,874 9 1,266,770 10 1,304,773 $ 11,463,879 PV @ 8% $ 7,550,134 Average Rent $ 1,146,388 26 © Copyright Tate & Tryon 2012
  28. 28. Example - Calculating the Liability and AssetLegal fees of $265,000 were incurred as part of the review of the lease document.Based on the lease term and rental payments analysis performed, the liability and assetare calculated as follows……. "LEASE LIABILITY" (PV for 10 years at 8%) $ 7,550,134 Add, direct costs (legal review) 265,000 "RIGHT TO USE ASSET" $ 7,815,134 27 © Copyright Tate & Tryon 2012
  29. 29. Example - Entries for year one… Debit Credit Year 1 Entry to record lease payment Cash $ 1,000,000 Lease expense $ 1,146,388 Lease liability $ 395,990 (A) Right of use asset $ 542,378 To record straight-line lease expense and corresponding reduction in lease liability. 1 Year 1 Entry to record direct cost amortization Amortization expense (??) $ 26,500 Right of use asset $ 26,500 To record amortization expense related to capitalized direct lease costs (A) - This is the "principal" portion of the annual cash payment. 28 © Copyright Tate & Tryon 2012
  30. 30. Items to consider each yearLease term: Have factors changed regarding economic incentives toexercise or not exercise renewal options. (Discount rate would alsochange.)Payments tied to an index: Recalculate future payments based on thecurrent year-end’s spot rate.Right of Use Asset: Assess for impairment. 29 © Copyright Tate & Tryon 2012
  31. 31. Transition Early adoption will likely be permitted. Generally a retrospective approach, with a number of modifications designed to make the initial application less onerous. However, full retrospective adoption will be permitted. Nonpublic entities will likely get more time. 30 © Copyright Tate & Tryon 2012
  32. 32. Good Luck! You might want to sneak away sometime before this all goes final...... 31 © Copyright Tate & Tryon 2012
  33. 33. Speaker BiographyDouglas Boedeker, is a partner within Tate & Tryon’s Audit andAssurance Services unit and is also actively involved in the Firmsexempt organization tax services group. He has 20 years ofexperience providing an array of audit, tax, and consultingservices to a variety of nonprofit organizations and employeebenefit plans. He takes particular pride that his family hascontained at least one CPA every year since 1923. Douggraduated summa cum laude from Susquehanna University inSelinsgrove, Pennsylvania with a Bachelor of Science degree inaccounting while simultaneously completing the coursework for asecond major in arts administration. Doug Boedeker, CPA, CMA Audit Partner Tate & TryonDoug is a frequent speaker on a variety of exempt organization Direct: 202-419-5106accounting and tax issues. He recently lead a session on dboedeker@tatetryon.compresenting the Form 990 & audited financial statements to anonprofit’s board of directors at the 2012 AICPA Not for ProfitIndustry Conference. Doug is a coauthor to Guide to the NewestIRS Form 990: Interpreting and Complying with the New TaxReporting Requirements for Transparency and Accountability,(published by ASAE). w 32 © Copyright Tate & Tryon 2012 w

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