2012 02 06 EFRAG presentation re lease accounting
-
Upload
roel-vriens -
Category
Economy & Finance
-
view
1.383 -
download
1
description
Transcript of 2012 02 06 EFRAG presentation re lease accounting
Navigating through the new lease regulations EFRAG
Roel Vriens, February 23, 2012
Navigating through the new lease regulations: EFRAG
2
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
Leasing - Current and expected future framework
Navigating through the new lease regulations: EFRAG
4
Differences local GAAP, IFRS and US GAAP
Lease payments Economic life
Local GAAP 90% (indication) 75% (indication)
IFRS IAS 17 ‘substantially all’ ‘major part’
US GAAP SFAS 13 90% 75%
Leasing: Current framework
} 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
Navigating through the new lease regulations: EFRAG
5
1996: first Discussion Paper (McGregor/IASB) in which the need to adapt rules was explained on a fairly detailed level
2009: IASB and FASB Discussion Paper ‘Leases: Preliminary Views’ with main focus on Lessees
2013: Final rules still expected in 2012? Re-exposure draft is expected in Q2 2012.
2000: Second Discussion Paper IASB
August 17, 2010: Exposure Draft as result of the 2009 Discussion Paper Over 785 companies, including DLL, have responded!
Effective Date not decided, expectation January 2016. But date of initial application (DIA) one or two years earlier, i.e., 2015 (IFRS) and 2014 (US GAAP)
1996 2000 2009 2010 2012 2016
Leasing: Expected future framework History
Overriding principle
All leases to be shown on the balance sheet of the
lessee
Navigating through the new lease regulations: EFRAG
6
} 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
Leasing: Expected future framework Lessor accounting: Receivable and residual approach
Navigating through the new lease regulations: EFRAG
7
} 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
Leasing: Expected future framework Observations
Expected business impact Lessees and Vendors/Lessors
Navigating through the new lease regulations: EFRAG
9
Statement
} 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
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
Navigating through the new lease regulations: EFRAG
10
The changing environment
} 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
Lessees
Navigating through the new lease regulations: EFRAG
11
} 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)
Expected customer impact Preparation for new rules
Navigating through the new lease regulations: EFRAG
12
The changing environment
} 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?
Vendors / Lessors
Navigating through the new lease regulations: EFRAG
13
Revenue deferral related to residual asset
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
Impact differs per major asset types / industries
Navigating through the new lease regulations: EFRAG
14
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
Is there still a future for leasing?
Navigating through the new lease regulations: EFRAG
16
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
Navigating through the new lease regulations: EFRAG
17
Vendors should continue to offer leasing to their customers
} 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
Because leasing puts vendor in control
Navigating through the new lease regulations: EFRAG
18
Vend
or L
easi
ng M
odel
End-user/ lessee
Lessor
Manufacturer/ vendor
Understanding the objectives of all the players in the market How can the structure be optimized?
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
Specific topics
Navigating through the new lease regulations: EFRAG
20
Consequences for lessees
} Higher lease cost in the beginning of the lease period compared to the current lease accounting standards
Lease cost comparison
100.00
150.00
200.00
250.00
Year 1 Year 2 Year 3 Year 4 Year 5
CurrentProposed
Navigating through the new lease regulations: EFRAG
21
} 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
Economic impact of lease proposals Study of Equipment Leasing and Finance Foundation
Navigating through the new lease regulations: EFRAG
22
} 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
Lease classification (current status)
Navigating through the new lease regulations: EFRAG
23
} 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?
Lease classification (future status) Concerns lease versus service classification – a new bright line?