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Transcript of 1 ELFA Annual Convention October 2011 Lease Accounting Changes—Understanding the Lessee Impact and...
1
ELFA Annual Convention
October 2011
Lease Accounting Changes—Understanding the Lessee Impact and
Strengthening Your Lessee Relationship
22
Agenda
• Project Timeline• Overview: Proposed Lessee
Models• Potential Impacts• Strategic Considerations• Remaining Advocacy Issues
33
Project Timeline
ED Issue
dAugus
t 2010
Redeliberations Jan 2011 - Ongoing
Comment LettersDec 2011
Timeline in not fixed• Dependent upon progress made and changes to new ED• Effective date uncertain, tied to revenue recognition –
likely to be 2015 or 2016
Outreach
Final Standard
2013
Comment
LettersT+120 Days
New ED Issued
2 QTR 2012
Draft New ED1 QTR 2012
Re-deliberate3/4 QTR 2012
44Proposed Accounting Models – Lessee and Lessor
LessorModels
LesseeRight-of-
Use Model
Recognize “right-of-use”
asset
Recognize liability to
make estimated
future lease payments
“Right to use” leased property
Lease payments
Recognize right to receive
estimated future lease payments +
residual asset Recognize
partial sales-type gross
profit
Derecognize leased
property
R&R Model
Operating Lease Model(Short term leases only)
• Leveraged lease eliminated
• PV estimated rents including interim rents, bargain renewals, value of RVGs
• P&L cost front ended = amortization of ROU asset + imputed interest
• No rent expense• Bifurcate or capitalize bundled
rents
55
Redeliberations
The Boards received nearly 800 comment letters, held public outreach meetings, and met several times with the Leasing Working Group. Main issues considered during redeliberations include:– Definition of a lease – fewer contracts will be leases– Lease term - simplified and moved back to current GAAP– Variable lease payments – simplified and limited capitalization– Options - simplified and moved back to current GAAP– Lessor accounting models – one basic DFL-like model plus short term lease
model• Eliminates leveraged leases• Eliminates operating lease accounting for all but short term leases• Sales-type gross profit accounting for all leases/residual portion
deferred– Bundled full service leases – bifurcate service portion to avoid
capitalization– Lease modifications, reassessments – Lessee cost allocation – front ends lease costs
66
Lessee People & Change Impacts Due to persuasive organizational change there is a need for a strong
project management office with an effective governance structure and communication protocols
Impacted departments will need appropriate communication and training to understand their role, the impact to their job responsibilities and their level of involvement in the ongoing support of the conversion project and ongoing accounting
Departments impacted outside of General Accounting and Financial Reporting will likely include Business Segment Management, CFO, Legal, Real Estate, Treasury, Internal Audit, IT, Tax, Budgeting, Regulatory, Contract Management, and Forecasting
Broad Impact on Lessees of Proposed Lease Accounting Standards Changes
Lessee Systems & Processes Impacts Existing systems likely do not have sufficient functionality to handle
new requirements of calculating right-of-use assets & lease obligations
Transition will require an inventorying of all leases across an organization, potentially including contracts not previously accounted for as leases (e.g., contract manufacturing, IT outsourcing arrangements)
Once leases are inventoried, physical documents will be needed to collect lease terms for every lease for input to a lease accounting system
Expanded data needs may necessitate a need for forecasting and other systems
Increased management judgment will elevate financial reporting risk, and will require changes to process documentation and SOX 404 testing
Lessee Business Impacts Significant financial statement changes for lessees:
– Increase in ROU & deferred tax assets impacts ROA calculations– Increase in liabilities impacts capitalization & debt to equity
calculations– Inclusion of additional contingent rents will accelerate expense
recognition– Rent expense replaced by amortization & interest increases
EBITDA – Front ended expense pattern = earnings ,capital issues & cost
reimbursement issues– Loan covenant breaches due to changes in GAAP treatment
Management may choose to review buy versus lease decisions Management may choose to evaluate the need to renegotiate
current lease terms
Lessee Accounting and Reporting Impacts Transition will be a major project Increased management judgment (e.g., lease term, options,
contingent rent, service components,, etc.) Increased level of effort & financial reporting volatility due to
ongoing remeasurement New “right of use” asset subject to impairment Added complexity in calculating book vs. tax differences – new def
tax asset Need to significantly amend accounting policies and procedures Increased disclosure requirements Initial valuation of opening balance sheet and preparation
comparative periods Need to support transition and ongoing external audit requirements
77
Lessor People & Change Impacts Accounting staff has to learn the new rules and transition rules Sales staff needs to know the new rules to respond to customer
objections and questions Products need to be reviewed for changes to maintain their viability
under the new rules (e.g. bifurcating service portion of full service leases, interim rent policies)
Existing target markets need to be reviewed New products need to be developed Strategies to deal with existing leveraged lease portfolio
Broad Impact on Lessors of Proposed Lease Accounting Standards Changes
Lessor Systems & Processes Impacts Existing systems likely do not have sufficient functionality to handle
new requirements of calculating PV receivable, residual and revenue recognition
Transition will require data collection for all leases for input to a lease accounting system
Lessor Business Impacts Significant financial statement changes for lessors:
– Leveraged leases grossed up, earnings flatter, ROAs reduced, capital hit for accounting change adjustment
– Operating leases, sales-type lease rebooked and new sales-type leases create new revenue recognition patterns
– Inclusion of additional contingent rents will mean remeasurement and adjustment
– Review residual insurance needs– Review existing securitizations for changes in presentation (e.g.,
residual guaranteed residuals are not financial assets)
Lessor Accounting & Reporting Impacts Transition will be a major project especially for leveraged leases Transition will impact capital, the balance sheet and forecasts –
leveraged leases, former operating leases and sales-type leases Increased management judgment (e.g., lease term, options,
contingent rent, service components,, etc.) Increased level of effort & financial reporting volatility due to
ongoing remeasurement Need to amend accounting policies and procedures New disclosure requirements Need to support transition and ongoing external audit requirements
88
Business Reasons for Leasing
Reason for Leasing
Details Status After Proposed New Rules
Raise Capital Additional capital source, 100% financing, fixed rate, level payments, longer terms
Still a major benefit versus a bank loan especially for SME & non-investment grade lessees with limited sources of capital
Low cost capital Low payments/rate due to tax benefits, residual & lessor low cost of funds
Still a benefit versus a bank loan
Tax benefits Lessee can’t use tax benefits & lease vs. buy shows lease option has lowest after tax PV cost
Still a benefit
Manage assets/residual risk transfer
Lessee has flexibility to return asset
Still a benefit
Service Outsource servicing of the leased assets.
Still a benefit
Convenience Quick & easy financing process often available at point-of-sale
Still a benefit
Regulatory Capital issues Partial benefit if the PV < cost of the asset, S/B true for hi residual assets w tax benefits
Accounting Off balance sheet Partial benefit if the PV < cost of the asset, S/B true for hi residual assets w tax benefits
99
Impact by Lessee Type
Lessee type Potential impact
Investment grade/large companies
Some negative impact as leases often accounting focused, have more sources of capital, more analytical staff, loss of leveraged lease product increases lease costs
Non-investment grade/small & medium sized
Less impact as source of capital is prime reason for leasing, fewer sources of capital, level payments & 100% financing conserves cash, less concerned about balance sheet optics, less staff to analyze lease and less analytical
Municipal/tax exempt No change in municipal market as GASB, not FASB, issues rules and operating leasing appears to be retained by GASB, tax exempt leasing offers lowest cost, leasing avoids issuing debt with all its constraints
1010
Impact by Asset Type
Asset type Potential impact
High residual – vehicles, aircraft, rail, construction, agriculture, medical, material handling
PV of rents (capitalized amount) significantly lower than cost of equipment = still some accounting benefit
Low residual – computers, copiers, faxes, office furniture and equipment
PV of rents (capitalized amount) closer to cost of equipment = little accounting benefit, interim rents (common in this segment) capitalized revealing a formerly ignored cost, when lease renewed must be rebooked raising attention to renewals which currently often occur without detection, trade ups (on books) get higher scrutiny
1111
Impact by Lessee Lease Type
Lessee lease type Potential impactCapital leases – Bargain PO/Auto title transfer
No change but now accounted for as a purchase and a loan.Use ROU method – capitalize PV of rents
Capital leases – Useful life/PV test
Use ROU method – capitalize PV of rents
Operating leases Use ROU method – capitalize PV of rents, Short term lease election to still use operating lease accounting
Synthetic/split-TRAC/fleet leases
Use ROU method – capitalize PV of rents and the likely payment under residual guarantee
Bundled full service lease
Bifurcate the bundled payment or capitalize full value
Muni lease Still an operating lease
1212
P&L Impact by Lessee Lease Term
Lease Term First Year Increase in Lease Cost – Proposed vs. Current GAAP
3 Years 7%
5 Years 12%
10 Years 21%
15 Years 26%
20 Years 28%
1313
Capitalized Value by Lease Type
Lease Type Terms Estimated Capitalized Value
PC lease 36 mos, 2.76% pmt, FMV with 15 day interim rent
91%
Fleet lease 12 mos, 2.5% pmt, 76% RVG (split TRAC)
29%
Construction equipment lease
36 mos, 1.6% pmt, FMV, 50% residual
52%
Cat Scanner lease
60 mos, 1.5% pmt, FMV, 20% residual
77%
1414
Impact by Lessor Lease Type
Lessor lease type
Potential impact
Leveraged leases
Eliminated. Existing leases grossed up on balance sheet, negative earnings adjustment charged to equity, future earnings “flatter”, ROAs/ROEs sub-standard. Alternative partnerships structures more costly to lessee and may be too complex for smaller deals and certain asset types.
Direct finance leases
No change but now called “receivable & residual” (R&R) method. Has same income pattern as current direct finance lease method. Guaranteed residual guarantee is not a financial asset.
Operating leases N/A except for short term leases. Good news for lessors as all but short term leases are R&R leases. Better earnings pattern. No need for residual insurance to turn operating leases into direct finance leases. Guaranteed residual guarantee is not a financial asset.
Sales-type leases
All but short term leases get gross profit up-front as in current sales-type lease accounting except the portion of gross profit related to the residual is deferred. Those lessors with high residual assets that were not direct finance leases under the old rules will get some up-front gross profit. On the downside lessors with low residual assets will have some up-front profits deferred. No need for residual insurance for accounting reasons.
1515
Strategic Considerations
• New products• Revise products• Markets – emphasize/de-emphasize• Customer service
• Disclose service components of full bundled lease payments
• Provide lessee accounting information• Sales training
• Understand proposed rules• Talking points• Dealing with objections
1616
Remaining Advocacy Issues
• Please be sure to comment when new ED is issued• For details see www.elfaonline.org
Issue Desired outcome Basis for request
Lessee cost pattern Maintain current straight line average rent expense for operating leases
•Reflects economic effects of an executory contract•Matches revenue with costs in rent reimbursement scenarios•Matches tax and legal view•Avoids bank capital adequacy issues
Leveraged leases •Grandfather existing deals•Retain some form of leveraged lease accounting
•Reflects economics of the transaction•Avoids capital adequacy issues•Reduces lease rates
Sales type gross profits deferred in proportion to residual risk retained
Allow residual guarantees and insurance to be considered in the profit calculation
A guarantee/insurance changes the residual’s nature to a financial asset
Sale leasebacks with a non bargain purchase option are considered a financing
The presence of a non bargain purchase option should not negate sale treatment
All the risks and most of the rewards in the asset’s residual value have transferred to the buyer indicating that a sale has taken place
The definition of the lease term for lessees is not clear
The term should include only renewals that are bargains or are a compulsion issue
Non bargain or non compulsory renewals are not obligations at lease inception.
Equipment lessors in medium term leases where the equipment is leased several more times must use the Receivable & Residual method
Lessors in the “operating lease” business should get investment property treatment as real estate lessors do
•Except for the fact that their leased assets are not real estate they otherwise meet the definition of investment property•Operating lease accounting best reflects the economics of their business
1717
Q&A
Questions?
Answers???