FASB Lease Accounting Standards

October 7, 2010LeasesRuss GoldenFASB MemberDanielle ZeyherFASB Project ManagerThis presentation has been prepared to help constituents understand the current status of projects of the FASB and IASB. The views expressed in this presentation are those of the presenter. Official positions of the FASB and the IASB are reached only after extensive due process and deliberations.

Agenda Overview of the FASBConvergence with IASBSummary of Proposed GuidanceOutreach Activities2

Overview of the FASBThe Financial Accounting Standards Board establishes standards of financial accounting that govern the preparation of financial reports in the private sector. Standards are officially recognized as authoritative by the SEC and the State Boards of Accountancy Source of Authoritative StandardsFASB Accounting Standards CodificationMission of the FASB:To establish and improve standards of financial accounting and reporting that foster financial reporting by nongovernmental entities that provides decision-useful information to investors and other users of financial reports.3

FASB Standards-Setting ProcessComprehensive and independent process that encourages broad participation and objectively considers all stakeholder views.The FASB is committed to following an open, orderly process for setting standards – comprehensive due process procedures. The process is designed to gather information from start to finish, and thereafter . . .4

Convergence: Improving quality and comparability of financial statementsHigh-Quality Global StandardsImprove and ConvergeImprove and ConvergeExistingInternational Financial Reporting Standards(IFRS)ExistingUS GAAPConsistent with Section 108 of Sarbanes-Oxley Act and 2003 SEC Policy Statement

FASB priorities: (1) process; (2) improvement; (3) convergence5

Norwalk Agreement and Memorandum of Understanding (MoU)Describe what convergence means and the tactics used by the FASB and the IASB to achieve it. Collaborate through joint projects to develop common standards. The FASB issues those standards as US GAAP and the IASB issues them as IFRSOvertime, the two sets of standards are expected to both improve quality and become increasingly similar if not the sameJune 24, 2010 – FASB and IASB revised the strategies, plans and milestones for each project6

Proposed Lease AccountingProject added to agenda July 2006Discussion paper March 2009Exposure Draft August 17, 2010Comment period ends December 15, 2010Outreach and fieldworkFINAL STANDARD planned 20118

Why did the FASB & IASB add the projectRules are very complex and consist of several bright-line tests (difficult to define the dividing line between capital and operating leases)Current operating lease accounting understates assets and liabilities and, consequently, indicators of leverage are understated and users adjust these indicators based on inadequate information in the notesIncreased focus on off-balance sheet financingGlobal activity; we should have a converged standard with IASBSEC’s off-balance sheet study 9

Overall Project ObjectivesTo develop a new model for the recognition of assets and liabilities arising under lease contractsLessors and lessees present relevant, faithfully representative information about the rights and obligations arising from leasesTo ensure that investors and other users of financial statements are provided useful, transparent, and complete information about leasing transactions in the financial statementsTo assist users of financial statements in their assessment of the amounts, timing, and uncertainty of cash flows arising from leases10

Summary of Proposed Guidance11

Summary of main proposalA lease is a contract in which right to use a specified asset is conveyed for a period of time in exchange for considerationLessees will account for all leases under the right-of-use approach, which records asset and liability for all leasesA hybrid accounting model will be required for lessorsPerformance obligation approach for leases that expose lessor to significant risks or benefits associated with underlying assetA (partial) derecognition approach would be applied to all other leases

ScopeLease definition – broad, but narrow in scope:“A lease is a contract in which the right to use a specified asset (the underlying asset) is conveyed, for a period of time, in exchange for consideration.”Apply this guidance to all leases, including leases of right-of-use assets in a sublease, except:Leases of intangible assetsLeases to explore for or use minerals, oil, natural gas and similar non-regenerative resourcesLeases of biological asset Include:Long-term leases of landNon-core assetsSimplified accounting for short-term leases:Lessee (optional): recognize gross asset and gross liabilityLessor (optional): use accrual accounting 13

Lessee modelLessee has acquired a right to use the underlying asset and is paying for that right with its lease payments14

16Lessor modelBased on exposure to risks or benefits of the underlying asset during or subsequent to the expected term of the lease contract

Counterparty credit risk is not consideredNoYes

Lessor model: Derecognition Approach17

Lessor Model: Performance Obligation Approach18

Renewal or purchase optionsPurchase option is not recognized until exercised!19

Example – Lease Term20An entity has a lease that has a non-cancellable 10-year term, an option to renew for 5 years at the end of 10 years and an option to renew for an additional 5 years at the end of 15 years. Assume that the entity determines the probability for each term as follows: There is a 60 percent chance that the term will be 15 years, which is the longest possible term more likely than not to occur. Therefore, the lease term is 15 years.

Contingent rent, penalties and RVGs21

Example – Contingent PaymentsCompany A enters into an arrangement to lease a retail outlet in an office building.

15-yr non-cancellable lease with no renewal options.

Annual lease payments of $2M/yr plus an additional contingent rent of 2% of gross revenue per year

Company A’s incremental borrowing rate is 8%

No purchase option or residual value guarantee Expected Contingent RentalsRight-of-Use Asset/Obligation

DisclosuresTo enable users to evaluate the nature, amount, timing, and uncertainty of cash flows arising from lease contracts and how the entity manages those cash flowsIncludes:Nature of lease contractsNature and amount of significant subleasesInformation about short-term leasesMaturity analysesSignificant assumption and judgments (including discount rate)Lessee: reconciliation of right of use assets and liabilities; information about sale and leaseback transaction Lessor: information about exposure to risks; impairment losses; reconciliation of (a) right to receive lease payments (b) lease liability (c) residual asset; class of residual assets; service obligations 23

TransitionAll outstanding leases at date of adoptionSimplified retrospective approachPresent value of remaining lease payments at:Incremental borrowing rate at date of adoption (lessee)Rate charged in the lease (lessor)Date of adoption = earliest period presented in F/SScope exception for transition“Simple” capital leases – carry forward prior accountingShort term leases 24

FASB Lease Accounting Standards

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FASB Lease Accounting Standards